The Bank of England is wor th a mention because it was the first modern central bank. It was established in 1694 but it is only in the nineteenth centur y that its operations star ted to differ greatly from central banks in continental Europe such as the Bank of France and the German Reichsbank. The latter both had branch networks and made loans directly to businesses. They accounted for a substantial propor tion of the banking business in each country.
The Bank of England was different because it had no direct lending to companies. It influenced credit conditions indirectly through its actions in tr ying to control, or at least have an impact on, the behavior of commercial banks. It did this primarily by adjusting the rate at which it would lend to commercial banks.
The Bank of England was established to act on behalf of the government. In the post Second World War period this meant that politicians effectively made many of its decisions. By way of contrast the German Bundesbank and US Fed both enjoyed a high degree of independence from political interference.
Political control meant that the Bank of England was usually required to increase money supply in the run-up to a general election by the party in power. This was intended to give the economy a short-term boost and the electorate the “feel-good” factor. Such an increase in money supply, without a corresponding increase in the real productive capacity of the economy, usually fed through to higher inflation, a depreciation (or devaluation) of the currency and a subsequent tightening of money supply. This gave rise to a period characterized by what became known as “stop-go” economics.
Around the turn of the century the Bank of England was given effective operational independence, being free to set sterling base interest rates and manage supply as it saw fit to keep inflation within a target range defined by Parliament. It also lost its responsibilities as a bank super visor to a newly established, unitar y financial ser vices regulator, the Financial Ser vices Authority (FSA).
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The Bank of England
Monday, October 12th, 2009The European Central Bank
Saturday, October 3rd, 2009The European Central Bank (ECB) was established following the decision of a number of European countries, including Germany, France and Italy, to adopt a common European currency.
Individual central banks had to relinquish their powers to manage money supply and set domestic interest rate levels. A few countries, such as the UK, opted out although in time that may well change.
There are clear advantages and disadvantages of having a common European currency. Cross-border transaction costs are reduced in part because there are no foreign exchange related charges for business conducted between members. Risks arising from companies having foreign exchange positions are also reduced. Business travelers and tourists in Europe no longer have to carry cash in a dozen different currencies.
The disadvantages stem from a lack of labor mobility and variations in national fiscal policies. In a unified economy such as the US workers will react to a downturn in one part of the country by moving to a part of the countr y with better economic prospects. This is much harder to accomplish in a continent with many different languages and where there is a limited tradition of cross-border labor movement.
National central banks’ ability to use monetary policy to influence economic growth, the level of unemployment and inflation have been largely subjugated to the ECB. They cannot cut interest rates, for example, to give a boost to a local economy in recession or hike rates to choke off inflation. The extent to which this lack of flexibility will result in future problems remains to be seen.
The ECB has specific quantitative inflation targets to meet but also has the power to take action against countries that fail to keep their government’s financing deficit as a percentage of GDP below a predetermined level.