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A history of central banking in great britain and the united states


A History of Central Banking in Great Britain
and the United States

Central banks in Great Britain and the United States arose early in
the financial revolution. The Bank of England was created in 1694,
whereas the first banks of the United States appeared during 17911811 and 1816-36 and were followed by the Independent Treasury,
formed from 1846 to 1914. These institutions, together with the Suffolk
Bank and the New York Clearing House, exercised important central
banking functions before the creation of the Federal Reserve System
in 1913. Significant monetary changes in the lives of these British and
American institutions are examined within a framework that deals with
the knowledge and behavior of central bankers and their interactions
with economists and politicians. Central bankers' behavior has shown
considerable continuity in the influence of incentives and their interest in the stability of the financial markets. For example, the Federal
Reserve's behavior during the Great Depression and the periods of low
inflation of the 1990s and its resurgence the next decade follow from its
structure and from government pressures rather than from accidents of
personnel.
John H. Wood is R. J. Reynolds Professor of Economics at Wake
Forest University, Winston-Salem, North Carolina. He has also taught

at the Universities of Birmingham, Pennsylvania, and Singapore and at
Northwestern University. A Life Fellow of Clare Hall, Cambridge, and
a Visiting Fellow of the American Institute for Economic Research,
Professor Wood has also been a full-time or visiting economist at the
Federal Reserve Board and the Federal Reserve Banks of Chicago,
Dallas, and Philadelphia. His earlier studies of central banking include
in 1967 the first application of the theory of economic policy to Federal
Reserve behavior. Professor Wood's research has appeared in leading
journals such as the American Economic Review, Journal of Political
Economy, Quarterly Journal of Economics, Journal of Finance, and

Journal of Monetary Economics.



STUDIES IN MACROECONOMIC HISTORY
SERIES EDITOR:
EDITORS:

Michael D. Bordo, Rutgers University

Forrest Capie, City University Business School, London
Barry Eichengreen, University of California, Berkeley
Nick Crafts, London School of Economics
Angela Redish, University of British Columbia

The titles in this series investigate themes of interest to economists and economic historians in the rapidly developing field of macroeconomic history.
The four areas covered include the application of monetary and finance theory, international economics, and quantitative methods to historical problems;
the historical application of growth and development theory and theories of
business fluctuations; the history of domestic and international monetary,
financial, and other macroeconomic institutions; and the history of international monetary and financial systems. The series amalgamates the former
Cambridge University Press series Studies in Monetary and Financial History
and Studies in Quantitative Economic History.

Other books in the series:
Howard Bodenhorn, A History of Banking in Antebellum America
Michael D. Bordo, The Gold Standard and Related Regimes
Michael D. Bordo and Forrest Capie (eds. ), Monetary Regimes in Transition
Michael D. Bordo and Roberto Cortes Conde (eds. ), Transferring Wealth and


Power from the Old to the New World
Claudio Borio, Gianni Toniolo, and Piet Clement (eds. ), Past and Future of

Central Bank Cooperation
Richard Burdekin and Pierre Siklos (eds. ), Deflation: Current and Historical

Perspectives
Trevor J. 0. Dick and John E. Floyd, Canada and the Gold Standard
Barry Eichengreen, Elusive Stability
Barry Eichengreen (ed.), Europes Postwar Recovery
Caroline Fohlin, Finance Capitalism and Germanys Rise to Industrial Power

Continued after the index



A History of Central Banking in Great Britain
and the United States

JOHN H. WOOD
Wake Forest University

MCAMBRIDGE

V

UNIVERSITY PRESS


CAMBRIDGE UNIVERSITY PRESS

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This publication is in copyright. Subject to statutory exception
and to the provisions of relevant collective licensing agreements,
no reproduction of any part may take place without the written
permission of Cambridge University Press.
First published 2005
Reprinted z.oo6
First paperback edition 2009
Reprinted 2.0 I I

A catalog record for this publication is available from the British Librury.
Library of Cong,-ess Catalogi11g in Publication Data
Wood, john H. (john Harold)
A history of central banking in Great Britain and the United States I John H. Wood.
p. em.- (Studies in macroeconomic history)
Includes bibliographical references and index.
ISBN o-521-85013-4 (hardcover)
1. Banks and banking, Central - Great Britain - History. 2. Bank of England - History.
3· Monetary policy- Great Britain- History. 4· Banks and banking, Central- United
States- History. 5· Board of Governors of the Federal Reserve System (U.S.)- History.
6. Monetary policy - United States - History. I. Title. II. Series.
HG2994.W66 2005
332. 1' I. 0941-dC22
2.00402.4984
ISBN
ISBN

978-o-521-85013-I Hardback
978-0-521-74131-6 Paperback

Cambridge University Press has no responsibility for the persistence or
accuracy of URLs for external or third-party Internet Web sites referred to in
this publication and docs not guarantee that any content on such Web sites is,
or will remain, accurate or appropriate.


To Norma, as always


Whoever, then, possessed the power of regulating the quantity of money
could always govern its value. But the currency ... was left entirely under
the management and control of a company of merchants - individuals, he
was most ready to admit, of the best character, and actuated by the best
intentions; but who, nevertheless, ... did not acknowledge the true principles of the currency, and who, in fact, in his opinion, did not know anything
about it.
David Ricardo, House of Commons, June 12, 1822
(N)o semblance of acquisitiveness prompts (the Federal Reserve Board's)
operations; no banking interest is behind, and no financial interest can pervert
or control it. It is an altruistic institution, a part of the Government itself,
representing the American people, with powers such as no man would dare
misuse.
Carter Glass, House of Representatives, September 10, 1913


Contents

page xii

List of Figures
List of Tables

xiv

Preface

xv

1. Understanding Central Bankers and Monetary Policy

1

2. An Introduction to Central Bankers
War. Inflation. Suspension, and More Inflation. 1793-1810
The Bullion Committee and the Macroeconomic
Responsibilities of the Bank of England
Banking, Central Banking. Knowledge, and Incentives to the
Public Interest
Rhetoric, Knowledge. and Monetary Policy

8
9

20
27

3. Making a Central Bank: I. Surviving
The First Hundred Years
The Resumption of 1821

32
34
47

4. Making a Central Bank: II. Looking for a Rule
Public Responsibilities
The Committee of 1832
The Bank Charter Act of 1844

60
62
67
75

5. Making a Central Bank: III. Means and Ends
Lombard Street
The Crisis of 1847
Contingencies and Commitments
Central Banking after Bagehot
Conclusion: Central Banking under the Gold Standard

ix

14

89
89
96
101
107
113


X

Contents
6. Central Banking in the United States, 1790-1914
New England Central Banks, 1824-1866
The First and Second Banks of the United States, 1791-1836
Money Centers and Clearinghouses, 1853-1913
TheindependentTreasur~1846-1914

'The National Banking System
7. Before the Crash: The Origins and Early Years of the Federal
Reserve
Origins: Who Wants a Central Bank?
Another Way: Keynes's Plan for a State Bank for India
Getting Started
Regulating Credit: Interest Rates or Discrimination?
A Model of Monetary (Credit) Policy? The Federal Reserve
Board's 1923 Annual Report
Price Stabilization
Conflicts in the Federal Reserve System
Federal Reserve Knowledge and Incentives on the Eve
of the Crash
8. The Fall and Rise of the Federal Reserve, 1929-1951
After the Crash
The Treasury Takes Charge
Riding the Tiger: Marriner Eccles, the Federal Reserve,
and the Executive
9. Central Banking in the United States after the Great
Depression, 1951 to the 1960s
Bills Only
Operation Twist
Bretton Woods
Markets Have Their Way

117
120
123
134
139
153
156
158
166
169
176
181
184
189
191
194
196
211
218
244
247
256
261
275

10. The Bank of England after 1914
Norman's Bank and the Return to Gold in 1925
The American Loan and the Resumption of 1947
Monetary Policy, 1945-1960: From Cheap Money to Stop-Go
The Bank, Prime Ministers, and the Pound: From One
Unmentionable to Another, 1951-1967
From Radcliffe to Competition and Credit Control

277
280
293
297

11. Rules versus Authorities
Interest Rules: Tooke, Wicksell, and the Quantity Theory
Money Rules
Econometrics and the Theory of Economic Policy
Free Reserves

328
330
336
340
342

314
323


Contents

xi

Democratic Central Banking
The Structure of the Federal Reserve

344
347

12. Permanent Suspension
The Economics of Frustration
Monetary Policy with a Floating Exchange Rate. August 1971
to October 1979

350
351

13. Back to the Beginning? New Contracts for New Companies
Turning Point
New Operating Procedures
New Contracts...
... Compared with the Old . . .
... And Their Prospects

375
377
382
389
397
399

References
Index

401

369

425


Figures

2.1. Bank of England notes and deposits, the rate of exchange on
page 16
Hamburg, and the price level, 1790-1825.
132
6.1. Position of the Second Bank of the United States.
6.2. Money, the dollar value of gold, the price level, and real GNP,
144
1861-79.
7.1. Required reserves and "free" gold of the Federal Reserve
175
Banks, 1919-23.
7.2. Changes in Federal Reserve credit and U.S. official gold
186
holdings, 1921-33.
8.1. Real GNP, price level, money supply, the prime commercial
paper rate, and the Federal Reserve Bank of New York
200
discount rate.
224
8.2. Excess reserves and borrowings, 1929-84.
237
8.3. Yields on U.S. T bills and long-term bonds, 1941-60.
9.1. Operation Twist: Treasury yield curves, January averages,
260
1961-65.
9.2. Gold value, production, and official reserves,
274
1800--1999.
10.1. Bank rate, unemployment, dollar value of sterling, and U.K.
and U.S. price levels, 1913-38.
285
10.2. Bank rate, inflation, and unemployment, 1947-78.
304
334
11.1. Market and natural rates of interest.
12.1. Rate of unemployment and annual rates of change of money
and consumer prices, 1965-75.
355

xii


Figures
12.2. FOMC ranges and actual money growth and the federal
funds rate, 1978.
13.1. The international value of the dollar, 1967-2003.
13.2. Actual and targeted inflation in New Zealand and the United
Kingdom, 1980-97.

xiii

371
381
392

Plates
I. The Old Lady of Threadneedle Street, 1797.

II. The downfall of Mother Bank.
III. Old lady (Punch).
IV. Deliverance at Hand. Ehrhart in .. Puck.··
V. Uncle Sam.
VIa-b. Secretary of the Treasury Fred Vinson makes the case for
multilateralism in congressional hearings on the
Anglo-American Financial Agreement.
VII. Federal Reserve Board Chairman William McChesney
Martin discusses the Board's increase in the discount rate,
which President Lyndon B. Johnson had criticized, at a
news briefing.

239
239
240
241
241

242

243


Tables

3.1. Bank of England Charters, 1694-1844.
5.1. Bank of England Return, September, 7,1844.
5.2. Selected Bank of England Returns, September 1846 to
December 1847, £ million.
8.1. Yields and Ownership of U.S. Securities, June 1942 to June
1947.
10.1. Official Reserves, 1949-58.
11.1. Average Preferred Interest Rates Estimated from FOMC

page 39
94
95
227
317
349
359

Votes.

12.1. Monetary Policy, 1964-70.
12.2. FOMC Directives before and after October 6, 1979.
13.1. Inflation, Interest Rates on Long-Term Government Bonds,

373
396

and Real Rates.

xiv


Preface

I have been involved in monetary policy only remotely in groups briefing
Federal Reserve Bank presidents for Federal Open Market Committee
meetings, but I have had numerous opportunities to observe policymakers
and their close advisors: as a graduate student at the Federal Reserve
Bank of Chicago, an economist at the Federal Reserve Board, and visitor
at the Federal Reserve Banks of Philadelphia, Dallas, and Chicago. It has
always been clear to me - at first very disapprovingly, then less so - that
central bankers do not see the world like economists. Examinations of
the statements and actions of earlier central bankers in Great Britain as
well as the United States convinced me that this has always been so.
I do not touch on the questions of whether central banks have been
more harmful than beneficial or whether they ought to exist, but rather
on understanding them. I hope the study will come across as a sympathetic inquiry by an economist into the knowledge and behavior of central
bankers - into what makes them tick. I give them no grades, but I hope

that a better understanding of the continuity of their behavior, while at the
same time recognizing that they are not immune to ideas, may promote a
more useful interaction between them and economists.
Much of the research and writing of this book took place at Clare
Hall, Cambridge, with its access to the University and Marshall Libraries,
and at the American Institute for Economic Research, Great Barrington,
Massachusetts. I am grateful to these institutions and to the above-thecall-of-duty editorial guidance and advice of Michael Bordo, Robert
Hetzel, and Anna Schwartz. Most of my other debts are revealed in the
citations to the many excellent studies of central banking of which I am
one of the fortunate inheritors.
XV



ONE

Understanding Central Bankers and Monetary Policy

Our monetary system is unprecedented. After decades of instability, central bankers, governments, and economists have reached a consensus that
the appropriate role of a central bank in the prevailing fiat-money regime
includes: (1) the clear assignment of the responsibility for inflation to the
central bank; (2) agreement that inflation should be low and stable; (3)
rejection of price controls as a means of controlling inflation; and (4) acceptance of whatever degree of fluctuation is required in interest rates to
achieve the inflation objective. This is at once more ambitious and more
modest (realistic) than earlier systems. The gold standard was a way to
price stability in the long run, and Keynesian monetary and fiscal policies
aspired to multiple (if inconsistent) price and quantity goals.
The system is not accidental. This book traces its development through
successive interactions of central bankers, economic ideas, and governments, all affected in greater or lesser degrees by the experiences of earlier
systems. There are several excellent histories of central banking for par-

ticular periods. 1 However, this is the first attempt to tie the threads across
1 Standouts include the authorized histories of the Bank of England by John Clapham (for

1797-1914), Ralph Sayers (1890-1944). and John Fforde (1941-58) and, for the United
States. Richard Timberlake's history of monetary policy from Alexander Hamilton to
Alan Greenspan and Milton Friedman and Anna Schwartz's Monetary History of the
United Swtes from 1867 to 1960. Further useful studies of British experiences are those of
T. Fortune. A Concise and Authentic History ofthe Bank of England, Thorold Rogers, The
First Nine Years of the Bank of England, A. Andreades, History of the Bank of England,
A. E. Feavearyear, The Pound Sterling. Marston Acres, The Bank of England from Within,
P. G. M. Dickson, The Financial Revolution in England: A Swdy in the Development of
Public Credit. 1688-1756, R. G. Hawtrey, A Century of Bank Rate, and Richard Roberts
and David Kynaston, The Bank of England: Money, Power and Influence, 1694-1994. An

1


2

Central Banking in Great Britain and the United States

three centuries within a unified framework that is made up not only of
monetary theory but of the situations of central bankers in the financial
markets. The story is told from the standpoints of central bankers in two
countries, from the establishments of the Bank of England in 1694 and
the Bank of the United States in 1791, although similar policy regimes in
Europe and elsewhere suggest that it has wider applicability (which will
be examined in the last chapter).
The focus on central bankers has several advantages for understanding the monetary system. Their position at the center provides a unique
perspective on the progress of events, and their responsibility for day-today policy gives their exchanges with governments insight into policy in
practice. The views of policymakers as revealed in the statements of Governors Whitmore, Harman, and Palmer before parliamentary inquiries in
1810, 1832, and 1848 are not found elsewhere; nor are Governor Hankey's
quarrel with the Economist's Walter Bagehot, Governor Lidderdale's reactions to the Crisis of 1890, Governor Norman's defenses of resumption
in the 1920s, the resistance of Governors Cobbold and Cromer to government pressures in the 1950s and 1960s, or Governor George's exposition
of the new consensus in 1998.2 The institutions of American monetary
policy have been more changeable, but Nicholas Biddle's defense against
Andrew Jackson's war on the Second Bank of the United States and
the explanations of Treasury monetary policies by Secretaries Guthrie,
Sherman, and Shaw and of Federal Reserve policies by Governors Strong,
Harrison, Eccles, Martin, Maisel, Burns, Volcker, and Greenspan are
equally valuable. Heads of Federal Reserve Banks were called governors before the Banking Act of 1935 {for example, New York's Benjamin
Strong and George Harrison); they were called presidents thereafter.
Finally, their common situation in the financial markets provides a
strong element of continuity to the development of central banks. We
American sample is provided by Parker Willis, The Federal Reserve System, Paul Warburg,
The Federal Reserve System: Its Origin and Growth, Randolph Burgess, The Reserve Banks
and the Money Market, Seymour Harris, Twenty Years of Federal Reserve Policy, E. A.
Goldenweiser, Federal Reserve System in Operation, Lester Chandler, Benjamin Strong,
Central Banker and American Monetary Policy, 1928-41, Elm us Wicker, Federal Reserve
Monetary Policy, 1917-33, and David Wheelock, The Strategy and Consistency of Federal
Reserve Monetary Policy,/924-33. Although Alan Meltzer's history ofthe Federal Reserve
from 1913 to 1951 did not appear until2003, many of its previously published components
are used.
2
Jeremiah Harman, Horsley Palmer, and Thomson Hankey were past governors on these
occasions (Richard Roberts and David Kynaston, eds., The Bank of England, 1694-1994,
app. 2)


Understanding Central Bankers and Monetary Policy

3

will see how central bankers' concern for financial stability has become
reconciled with monetary policy. Technology has developed, but the fundamental characters of money and the credit markets, as well as of reputation and speculation, persist. Central bankers' earliest and longest
experiences were within the framework of the gold standard, but their
intellectual positions have been similar under paper standards.
Instead of treating monetary episodes as distinct, I examine policy as
a sequence of actions by durable groups with shared experiences and environments. In the 18th century, the Bank of England- the model central
bank (although its directors had to be told at the end of the century that
this is what they had become)- focused on profits and survival, the latter
requiring the payment of gold on demand for its notes. The long 19th century- unti11914- saw the progress of the Bank's acceptance of a wider
responsibility for financial stability, although convertibility remained in
ascendance. The United States had no institution that could be called a
central bank- except two short-lived Banks of the United States between
1791 and 1836- before the establishment of the Federal Reserve in 1913.
Nevertheless, the federal Treasury Department, central money markets,
and clearinghouses performed central banking functions that were governed by the same ideas that prevailed across the Atlantic, that is, profits
for private institutions and seigniorage for the government, subject to
currency convertibility and with attention to financial stability.
Central bankers failed to cope with the disruptions of World War I and
the Great Depression of the 1930s and tended to make matters worse as
the old system collapsed. Monetary theory and practice since that time
have to a large extent been quests for an adequate replacement of the
pre-1914 system. The dollar-exchange system that was agreed at Bretton
Woods in 1944 to achieve the solidity of the gold standard without its
rigidity proved inconsistent with concurrent monetary stimulations, and
its breakdown in the 1970s presaged an agonizing period of accelerating
inflation and unemployment.
The anti-inflationary monetarist policies associated with Federal Reserve Chairman Paul Volcker and Prime Minister Margaret Thatcher
may be understood as reactions to inflations that had failed to bring the
promised benefits, and monetary debates since 1979 have led to the consensus just described. Commitments to the new policy were legalized in
the Bank of England Act of 1998 and, less formally in the United States,
by the statement of Chairmen Volcker that "price stability ... is to be
treasured and enshrined as the prime policy priority; that objective is
inextricably part of a broader concern about the basic stability of the


4

Central Banking in Great Britain and the United States

financial and economic system" and that of Chairman Greenspan, who
stipulates, "Monetary policy basically is a single tool and you can only
implement one goal consistently. "3
Nonetheless, we must pay attention to Greenspan's warnings of "irrational exuberance in the stock market," as well as his worries of a shift
in bankers' attitudes toward risk during the 1998 Asian financial crisis:
"If there was a dime to turn on," they did, he said. A "fear-induced psychological response is provoking a sudden rush to liquidity that poses a
threat to world economic growth .... When human beings are confronted
with uncertainty ... they disengage." Comparing investors to a pedestrian
crossing the street, he observed, "When ... you're uncertain as to whether
a car is coming, you stop.'"'
Economists have been critical of central bankers' attention to the financial markets at the expense of their macroeconomic responsibilities.
Allan Meltzer was in the tradition of David Ricardo when he told a congressional committee in 1964 that the Federal Reserve's "knowledge of
the monetary process is woefully inadequate, ... dominated by extremely
short-run week-to-week, day-to-day, or hour-to-hour events in the money
and credit markets. [T]heir viewpoint is frequently that of a banker rather
than that of a regulating authority for the monetary system and the
economy. "5
Notwithstanding these criticisms, we will learn how central bankers'
understanding of their role in monetary policy has grown. The stage for
the intellectual gap between the two groups is set in Chapter 2, which
examines the Bank of England's denial of the Bullion Committee's charge
of economy-wide effects of what the Bank saw as normal lending practices.
Its rejection of the risks and responsibilities of managing the currency was
the occasion of Ricardo's censure that opens the book. We will encounter
more instances of this difference in viewpoint, but jumping ahead to 1998,
we see that the conflict between the career central bankers and economists
on the Bank's Monetary Policy Committee (MPC) was similar to that
between the Bank and the economists on the 1810 Bullion Committee.
According to the Monetary Policy Committee's minutes, although the
staffs economic model recommended a rise in the Bank's interest rate,
Bank careerists favored "delaying any rise in interest rates, even if a rise
3
4

5

Forrest Capie et al., eds., The Future of Central Banking, pp. 258, 343.
Wall Street Journal, Dec. 9, 1996, p. Ct. and Oct. 8, 1998, p. A2.
The Federal Reserve System after Fifty Years, Hearings before the Subcommittee on
Domestic Finance of the Committee on Banking and Currency, 88th Cong., 2nd sess.,
Feb. 11, 1964,pp.927,932.


Understanding Central Bankers and Monetary Policy

5

were necessary.'~ They referred to "unusually large" near-term uncertainties and did not "feel very confident about the outlook and it would
not necessarily be right to draw policy conclusions mechanically from the
[staff's] projection. In these circumstances there was a case for delay so as
to allow judgment to be made later in the light of more information." If
the downturn proved sharper than expected, an increase in interest rates
might have a severe negative effect on output, "and would have to be
quickly reversed. Such a reversal could impair confidence in the economy" and create "confusion about monetary policy.... There was thus a
strong case for waiting to get a clearer impression of the extent of the
slowdown in the economy before taking policy action. "7
This thinking was like that of the Bank directors in 1819, who protested
Ricardo's money rule as "fraught with very great uncertainty and risk"
in which "discretionary power is to be taken away from the Bank," and
might, because of the impossibility of deciding "beforehand what shall be
the course of events," impose "an unrelenting continuance of pecuniary
pressures upon the commercial world of which it is impossible for them
either to foresee or estimate the consequences."
The 1998 Committee's academic economists opposed this position by
arguing that "policy should reflect the latest news and that uncertainty in
itself was no reason for delay." They believed that to delay decisions toreduce the risks of reversal was "irrational." "So long as any policy reversals
could be properly explained by new developments or improved analysis of
the outlook, they need not create confusion about policy.... [T]he desire
to minimise the risk of policy reversals was likely to mean that interest rate
changes would, on average, be made too late." The tie vote was broken
by Governor George in favor of waiting.
Economists have found it "difficult to rationalize" central bankers'
concern for smooth interest rates and short-term stability in the financial
markets.8 Nonetheless, they must take it into account. Central bankers
cannot help behaving like bankers at least part of the time. Rules are
incomplete, and if economists hope to explain and influence the conduct
6

7

!!

Those with histories as primarily academic economists on the Monetary Policy Committee were Sir Alan Budd, Professors Willem Buiter and Charles Goodhart, and Deputy
Governor Mervyn King; those with careers at the Bank or in industry were Governor Edward George, Deputy Governor Ian Plenderleith, David Clementi, and DeAnne
Julius.
This and the next paragraph are from MPC minutes for February and May 1998, Bank of
England, Inflation Report, May and August 1998.
Lars Svensson, "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy
through Targeting Rules."


6

Central Banking in Great Britain and the United States

of monetary policy, they need to try to understand central bankers on
their own ground. Central bankers are informed parties to the new consensus, but monetary policy results from the interplay of central bankers'
pragmatism with economists' ideas and the wishes of governments.
The latter- the ultimate authority- cannot be ignored. The freedoms
that central banks have been given can be taken away. Past government
attitudes toward central banks have depended on their need for them.
The end of war (and government pressure for cheap finance) brought an
increase in the Bank of England's independence in 1833 similar to that
given in 1998. President Jackson's veto of the renewal of the charter of
the Bank of the United States in 1832 was influenced by the approaching
end of the national debt. Senator Thomas Hart Benton declared, "The
war made the Bank; peace will unmake it. •/J
The greater independence of the Federal Reserve after the collapse
of the Soviet Union might have reflected the government's diminished
need for finance as much as the public's revulsion to inflation and disillusionment with the Phillips Curve. By the same token, the deficits arising
from the War on Terror will bring pressure for monetization. In any case,
monetary policy is at bottom a political decision.
Legislatures have also paid attention to central banks in peacetime,
especially during the periods of price instability following wars, during
the Great Depression, and in the 1970s. Monetary standards are decided
by governments. The creation of the International Monetary Fund in
1944 and its rejection by President Nixon in 1971 were not unusual in
the minimal roles played by the central bank. Wartime suspensions, devaluations, gold standard acts, and the creation of the Federal Reserve
were political decisions. The task of central bankers even at the height of
"independence" is the daily conduct of policy within the framework set
by government.
Governments have taken direct control of monetary policy when they
lost confidence in central banks. Their institutional shells remained, but
monetary control was transferred in the early 1930s to the 1reasury in
both countries. The Federal Reserve regained control in 1951 when public opinion and Congress determined that the president had abused his
monetary powers, a victory that had to be won again in 1979. The Bank
of England, although possessing advisory influence, did not approach its
former powers until the 1990s.
lJ

U.S. Senate, February 2, 1831; Herman Krooss, Documentary History of Banking and
Currency in the United States, p. 736.


Understanding Central Bankers and Monetary Policy

7

The last chapter surveys the present and speculates about the future of
central banking. The current consensus rests on an understanding, developed over many years of hard experience, of what monetary policy can
do. Central bankers apparently understand their assignment, although
history shows that they also take the financial markets and political pressures seriously. Nevertheless, if we accept the goal of low inflation in free
markets, with the understanding that this is the best that monetary policy
can do, central bankers will be able to adjust to unusual events in ways
that substantially deliver the goal while smoothing the financial marketssuch as when the Federal Reserve supplied liquidity after the 1987 stock
market crash, during the run-up to the millennium, and after 9/11, and
also when it tries to soften the impact of monetary policy on the money
markets by improving its transparency. 10
111

Such cases include the asymmetric directive and the promise in August 2003 oflow interest
rates "for a considerable period"; Daniel Thornton and David Wheelock, "A History of
the Asymmetric Policy Directive," and Richard Anderson and Daniel Thornton, "The
FOMC's ·considerable Period'."


TWO

An Introduction to Central Bankers

Do you consider the amount of Bank of England notes during the last year
to have borne nearly the same proportion to the occasions of the public as
in former times? - The same proportion exactly.
When you represent the quantity of Bank of England notes to be now
only proportionate, as heretofore, to the occasions of the public, do you
take into consideration the increased price of all articles and the consequent
increase of the amount of payments; and do you assume that the quantity
of notes ought to be increased in proportion to that increase of the amount
of payments? - The Bank never force a note into circulation, and there
will not remain a note in circulation more than the immediate wants of the
public require; for no banker, I presume, will keep a larger stock of [the
Bank's] notes by him than his immediate payments require, as he can at all
times procure them ...
[Question repeated]- I have taken into consideration not only the increased price of all articles, but the increased demands upon us from other
causes.
Minutes of Evidence, Bullion Committee, testimony of Governor
John Whitmore, Bank of England, March 6, 1810

So went the opening exchange between the House of Commons' Select
Committee on the High Price of Gold (Bullion Committee), with Francis
Horner in the Chair, and the Bank of England, represented by Governor
Whitmore. This testimony played an important part in the beginnings
of modern monetary theory and the intellectual discovery of central
banking. Economists contended that the latter - monetary policy properly derives from the former, while the central bankers resisted.
The events surrounding the inflation that led to Parliament's enquiry are
presented in the first section in this chapter, followed by a review of the
8


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