The Bank of England's Monetary Policy

By Tootell, Geoffrey M. B. | New England Economic Review, Spring 2002 | Go to article overview

The Bank of England's Monetary Policy


Tootell, Geoffrey M. B., New England Economic Review


As the second oldest and perhaps the most renowned central bank, the Bank of England could provide some important insights into issues that may confront the Federal Reserve System in the future. The next section provides a brief review of the Bank's history, while the second section discusses its current procedures. A brief conclusion follows.

A Brief History of the Bank of England

The Bank of England was chartered as a joint stock company in 1694 in return for a loan of [pound sterling]1.2 million to the government. In addition to its commercial activities, it was expected to handle the government's accounts and to assist with its funding. Although the Bank immediately began issuing notes, not until 1709 did it achieve a virtual monopoly in note issuance. Eventually, the Bank both provided settlement services between banks and assumed responsibility for the stability of the banking system as a whole by acting as the lender of last resort.

At the beginning of the nineteenth century a rise in gold prices sparked a serious debate over the Bank's purpose. Participants were divided into two camps: the currency school and the banking school. The currency school argued that for currency stabilization, currency issuance should be strictly tied to gold deposits. The banking school countered that monetary and macro stability depended on all of the Bank's liabilities, not just notes. Vestiges of this debate can still be seen in the accounting structure of the Bank; by the Bank Charter Act of 1844, the Bank was, and still is, separated into two departments with their own balance sheets. The role of the note issuance department was to ensure that the currency was fully backed, while the banking department was expected to carry on as a normal commercial bank, with its own separate balance sheet. Thus, given the responsibilities of the Bank at the time, its assets consisted of specie, government debt, and bank bills.

De facto, the spirit of the Act was repealed almost immediately. A consensus soon arose that consideration of all the Bank's liabilities, not just notes, was important to achieve its larger goals of convertibility, under the gold standard, and macro stabilization. Furthermore, concerns arose that the Central Bank's role as a commercial bank could interfere with the attainment of its macro goals. (1) From the moment the 1844 Act was passed, the Bank was pressured to unify its two departments and minimize its commercial functions. Although the two departments have never officially been unified, toward the end of the nineteenth century, the Bank's commercial function was limited. (2) But, it was not until the 1920s that the Bank finally eschewed commercial business. Since then, the Bank's actions have been determined by its macro goals.

Of course, when the government ran large deficits, the Bank's objective of a stable currency came into conflict with its obligations to assist with the government's funding. The Bank often resolved that conflict by temporarily suspending convertibility, as it did during the Napoleonic Wars and the world wars.

Britain went off the Gold Standard in 1931, and the mission of the Bank was altered. Under the Bank of England Act of 1946, complete ownership of the Bank passed to the government. The goals of the central bank again changed. Convertibility, however, still played an important role, as Bretton Woods forced the government to conduct policy consistent with a fixed dollar/pound exchange rate. Yet, the goal of maintaining full employment now moved into the foreground. To help attain these multiple goals, the Bank relied heavily on quantity controls on the creation of credit. (3) When the two goals appeared to be hopelessly in conflict, the exchange rate was altered.

Movements toward central bank independence eventually led to the 1998 Bank of England Act. The Act gave the Bank freedom in setting the monetary instrument, the interest rate. …

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