the business of central banks

[Central Bank origins] usually were remote from control of inflation or output or anything resembling modern macroeconomic policy. The Bank of England was established in 1694 by a group of City merchants lending money to finance the wars of William III. Even the US Federal Reserve, which was founded much later in 1913 in response to the bank crisis of 1907, was primarily concerned with the stability of the commercial banks. In the 19th century rough price stability was expected to result from using gold as the ultimate form of money. The role of the central bank was to ensure that, despite any paper money or other credit instruments issued by governments, the gold convertibility of the currency was maintained. In the course of the 20th century the gold link was … cut. Thus central banks were left by default with the task of maintaining the value of the currency. Even then many were just as concerned with the welfare of commercial banks and the financial system as a whole.

How have they performed in their enlarged role? At a cursory glance, none too well. So far from curbing the notorious German hyperinflation of the 1920s, the then head of the Reichsbank plaintively observed that he was printing money as fast as the machinery at his disposal allowed. At the Bank of England, governor Montagu Norman bullied Winston Churchill into returning to gold in 1925 at an overvalued parity, which helped trigger the General Strike the following year. Later he prevented the 1929-31 Labour government from embarking on public works to counter rising unemployment. Worst of all was the unwillingness or inability of the Fed to prevent a massive decline in the US money stock at the onset of the Depression.

There followed a gap of several decades in which central banks were demoted. But it can hardly be said that they have achieved distinction in more recent years.

Samuel Brittan, “Take central banks down a notch”, Financial Times, 30 July 2010.

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