Bank of England
The Bank of England is the central bank of the United Kingdom.
It acts as the government’s bank, regulates the money stock growth rate and the
availability of credit, and serves as a banker’s bank for commercial banks,
making loans and holding deposits. Like all central banks, it holds the
exclusive privilege to issue bank notes (paper money). Sometimes referred to as
the Old Lady of Threadneedle Street, the Bank of England sits at the center of
the London financial center.
The government planned to borrow 1.2 million pounds at a moderate 8 percent interest. To attract funds on the scale needed at that interest rate, Parliament granted the subscribers to the loan the privilege of pooling their funds and incorporating themselves under the name of the Governor and Company of the Bank of England. The debate in Parliament over this act raised quite a howl, including predictions that the Bank would encourage fraud, gambling, and the corruption of national morals.
Initially, Parliament granted the Bank of England a charter for 10 years. This charter authorized the bank to trade in gold, silver, and bills of exchange, and to issue bank notes equal in amount to its capital. It prohibited the bank from selling merchandise, excepting what had been held as security for unpaid loans. The charter put the management of the Bank of England in the hands of a governor, deputy governor, and 24 directors, elected yearly by the stockholders.
Parliament continued to renew the bank’s charter, usually in return for loans to the government, often at lower interest rates. Parliament renewed the bank’s charter in 1709 and added a provision that no other joint-stock company with more than six partners could issue bank notes, a provision that eventually gave the Bank of England a dominant position in the issuance of bank notes. In 1751 the bank took over the administration of the national debt, and by 1780 the bank had a virtual monopoly on the issuance of bank notes in London. The Bank of England began to wear the aspect of a central bank as smaller banks began the practice of keeping funds on deposit with it.
Originally conceived to raise money to fight a war, the bank underwent a particularly innovative period of development during the wars with revolutionary France and Napoleon. Over the protests of the bank’s directors, the bank was forced to accommodate the financing needs of the government for unlimited amounts. The bank began issuing notes in much smaller denominations, and in 1797 the bank, with approval from Parliament, suspended the convertibility of its bank notes into specie. Government borrowing had weakened the bank’s reserve position and bank note holders were making a run on the bank. Even though they were now inconvertible, the value of Bank of England bank notes stood up well because the government accepted them at par value in all payments and in 1812 made them legal tender. Country banks began to hold Bank of England notes as reserves for their own bank notes.
After resuming convertibility of its bank notes into specie in 1821 the Bank of England saw its bank notes grow in acceptability relative to gold. The country banks found the notes just as useful as gold for managing a cash drain, and began to look to the Bank of England as a place to borrow funds in a liquidity crisis. In 1833 the British government again declared Bank of England notes legal tender for sums above 5 pounds so long as the notes remained convertible. As Bank of England notes replaced gold as the circulating medium, the bank became the major holder of gold reserves.
At first the Bank of England resisted the pressure to become a lender of last resort in financial crises, still seeing itself as a bank competing with other banks, rather than a source of succor to competing banks in a financial crisis. The bank discovered, however, that adjusting its bank rate of interest to compete with other banks destabilized markets. After the crash of 1847 the bank began accepting its role as a lender of last resort and using adjustments in its bank rate of interest to stabilize money markets.
The years preceding World War I saw the bank become the custodian of the gold standard, and develop methods of using the bank rate of interest and open market operations to regulate interest rates, and the inflow and outflow of gold. During World War I the government outlawed the export of gold, and after the war the bank became a strong voice favoring restoration of the gold standard, notwithstanding the high interest rates required to prevent an outflow of gold reserves. The high interest rates needed to maintain the gold standard were out of step with the needs of the time, and in 1931 Parliament passed the Gold Standard (Amendment) Act, suspending the gold standard. The bank was never quite the same after the loss of the gold standard, and the government gave the bank very little guidance as to what policies to follow after the suspension.
During the years between the two world wars the Bank of England’s policies came under closer scrutiny and drew more criticism. In particular the Macmillan Committee in Parliament inquired into the full range of activities of the bank and criticized the bank for not being more committed to the methods of monetary management used by central banks —perhaps because of the bank’s loyalty to the outmoded gold standard.
The success of the government-directed war economy led a new Labour government in Parliament to embark upon a program of nationalization of major industries after World War II. Controversy over the policies of the Bank of England before the war made it an obvious target. It was nationalized in 1946 and brought under the authority of the Exchequer, or British treasury. With elected officials exerting much more influence over monetary policy, the Bank of England lost some of its reputation for financial probity. During the inflation-ridden 1970s Britain suffered much higher inflation rates than Japan, the United States, and West Germany. During the 1980s tight monetary policies brought down inflation, and by the late 1990s there was talk of again privatizing the Bank of England.
The Bank of England is represented on the General Council of the European Central Bank, but so far England has opted not to participate in the introduction of the euro, the all-European currency. The euro will eventually replace the German mark, the French franc, and the currencies of other participating European countries.
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