OPINION |

The Short History of Central Banking

THE SYSTEM OF CENTRAL BANKS HAS BEEN IN EXISTENCE FOR LESS THAN TWO CENTURIES AND IS STRONGLY TIED TO THE EVOLUTION OF GLOBAL FINANCE. IT HAS SELDOM BEEN EFFECTIVE IN STAVING OFF CRISES

by Gian Luca Podesta', Dept. of Policy Analysis and Public Management, Bocconi
Translated by Alex Foti


Central banking is a relatively modern phenomenon, going back to the 19th century. Certainly, there were precedents such the Casa di San Giorgio (1407), which operated as the Treasury of the Republic of Genoa, or the Riksbank (1656), which, following a debasement of coinage with copper coins and a surge of inflation, was authorized to print paper money by the Swedish monarchy. But these were contingent and pioneering episodes.

Much more important for the future of central banking was the foundation of the Bank of England in 1694 and John Law’s experiment, who, in order to replenish the coffers of the French monarchy which had been emptied by Louis XIV’s spending on continuous wars and his lavish court, was authorized by the regent Philippe d’Orleans to put in place a complex financial architecture with Banque Génerale at the center. The bank was authorized to issue payment certificates with which taxes could be settled, and equity of the government-sponsored Compagnie du Mississippi could be bought.

Until the 19th century, the most fearsome competitor of central banks was the free banking system, born in Scotland and praised by Adam Smith, whereby the Scottish Banking Act of 1765 authorized every banking institution or individual banker to issue banknotes.

The Bank Charter Act of 1844

By convention, the history of modern central banking starts in 1844, when the British government promulgated the Bank Charter Act, which effectively made the Bank of England the bank of banks, granting it monopoly over money printing and entrusting it with the task of financial stability, by acting as lender of last resort.

Starting with the late 1800s the Bank of England became the coordinator of the fledgling central banks emerging in the other economic powers, with the aim of stabilizing international economic relations and exchange rates in the gold standard monetary system. Finally, in 1913 also the US followed suit by instituting the Federal Reserve System. Starting with the financial crisis of 1873, and especially in the aftermath of the Great Crisis of 1929, central banks consolidated their power, and their role became crucial after 1945 to accommodate the expansionary fiscal policies launched by many Western governments, while retaining their traditional independence.

The history of central banking is tightly connected to the history of global finance. In a Darwinian model, crises are the ideal setting to assess the effectiveness of monetary institutions. From this point of view, the maxim dear to politicians, according to which staff generals are ready to fight the past war rather than the current one, seems to apply to central bankers, too. In fact the response of monetary authority to the crash of financial markets and ensuing panic was modeled on the experience of past crises, rather than present one.

Since the end of the Bretton Woods international monetary system, and especially after the demise of the bipolar world, which for better or worse kept the world in balance until 1989, Euro-American relations have grown more tepid. The disproportionate role that global finance has come to play tends to generate a succession of ever-more frequent crises, as the experience of the last twenty years tells us. In response to the 2007-2008 shock, the Fed and the BCE chose two different approaches. It goes without saying that, no matter how independent, all central bankers are subject to moral suasion by political power. Economists who have read either Milton Friedman or John Kenneth Galbraith, Barry Eichengreen or Charles Kindleberger are well aware that before and after 1929 serious errors were made in monetary policy which aggravated the Great Depression. It would be great to find out how, fifty years from now, historians and economists will judge the course of action taken by Ben Bernanke and Mario Draghi during the Great Recession.

Latest Articles Opinion

Go to archive
  • Occupational Downgrading Puts Mental Health at Risk

    Immigrants tend to be overqualified for the lowskilled, highrisk occupations that they tend to take up. A research study shows that this fact increases the risk of psychological disorders

  • With Increasingly Flexible Work, the Old Stakes Are of Little Use

    New work time arrangements and forms require new ways of management and new protections. And therefore, new forms of labor relations and union organizations

  • Trust That Can Be Trusted

    There is social trust and institutional trust. And if the former is more stable to external shocks, the latter is more sensitive to them. The two can also diverge, as during the pandemic, when mistrust in US institutions towards emergency management corresponded to an increase in social trust

Browse the magazine in digital format.

View previous issues of Via Sarfatti 25

BROWSE THE MAGAZINE

Events

Mon Tue Wed Thu Fri Sat Sun
        1 2 3
4 5 6 7 8 9 10
11 12 13 14 15 16 17
18 19 20 21 22 23 24
25 26 27 28 29 30 31