Victorian Central Banks and the Myth of Independence

By Pierre Ortlieb, s a graduate student, writer, and researcher based in London. He is interested in political economy and central banks, and currently works at a public investment think tank (the views expressed herein do not represent those of his employer). Originally published at Economic Questions

Donald Trump’s most recent feud with the Federal Reserve reached a new peak late last week as the U.S. President lambasted the institution’s policy stance. “I don’t have an accommodating Fed,” he noted. Commentary on Trump’s outburst is perhaps even more alarming than his words themselves. For instance, The Week noted that Trump’s encroachment on Fed independence was “essentially unprecedented”; imperiling the central bank’s status as a guardian of price stability was reckless, foolish. This reading of the history of central banks is misguided, however. Our current paradigm of independent central banks deploying their tools to maintain low inflation is a deeply contingent historical phenomenon and obscures central banks’ frequent role as publicly-controlled institutions and fiscal buttresses throughout their centuries of existence.

The contemporary notion of independent, conservative central banks was enshrined gradually over the 1990s, a decade in which over thirty countries – developed and developing – guaranteed the legal and operational independence of their monetary authorities. This institutionalization of inflation-averse central banks has come hand-in-hand with an aversion to “inflationary” deficit financing and fiscal expansionism, which has been restrained by an exclusive focus on price stability. This has come to be treated as the best practice approach to central banking, a paradigm which, until recently, was rarely questioned among policymakers. Reaction to Donald Trump’s comments has been emblematic of this.

Yet the history of central banks shows them to be far more intertwined with states and treasuries than current commentary or policy would suggest. At their founding, central banks frequently served not as constraints on the state, but rather as fiscal agents of the state. The inception of the Bank of England (BoE) in 1694, for example, was the result of a compromise that granted the state loans to finance its war with France, while the BoE was granted the right to issue and manage banknotes. As a result of this bargain, the market for public debt in the United Kingdom exploded in the 18th century, and government debt peaked at 260 percent of GDP during the Napoleonic wars. This both facilitated the expansion of Britain’s hegemonic financial position and enabled the industrial revolution, as borrowing at low risk made vast industrial development possible.

Direct state financing was, however, not the only means through central banks fostered favorable monetary conditions and growth during this era. The use of various “gold devices” to manage credit conditions from within the straitjacket of the gold standard was commonplace. The Reichsbank, for example, granted interest-free loans to importers of gold and inhibited gold exports to establish de facto exchange controls and some degree of exchange rate flexibility.

Various central banks also pursued sectoral policies, lending government-subsidized credit at lower real interest rates to key developmental industries. The 1913 Federal Reserve Act, for instance, was designed such that it would improve the global competitiveness of New York financial institutions. It is important to note that at the time, these central banks were largely established as private institutions with government-backed monopolies; yet this did not alter the fact that, in practice, they served as crucial instruments for the expansion and development of Western economies. Beyond the US and the UK, central banks across Western Europe, such as the Banque de France (1800), the Bank of Spain (1874), and the Reichsbank (1876), served a similar initial function as developmental agents of their respective states.

Nevertheless, this was not a uniform or constant system. The existence of the gold standard itself constrained the use of monetary instruments to foster growth across developed economies during the late 19th century. Furthermore, Victorian-era British policy came to revolve around sound finance and fiscal discipline, as the use of a central bank to finance the national state was increasingly in tension with Britain’s central position in the international trading system. Inflationary fiscal deficits were seen as inhibiting growth and dampening international investment. This “Victorian model” focus on price stability produced a paradigm shift in the UK away from expansionary deficit financing towards more restrained policy.

Despite interludes, the use of central banks as macroeconomic instruments endured and emerged reinforced in the aftermath of the Great Depression and the Second World War. After 1945, governments across the Western world adopted full employment objectives as part of the consensus of “embedded liberalism,” a practice which often also involved nationalizing central banks, so they could serve as tools of macroeconomic policy. Credit allocation came to serve social goals, and central banks were given additional tasks such as managing capital flows to maintain low interest rates. In France, the Banque de France was brought under the umbrella of the National Credit Council, the institution charged with managing financial aspects of government industrial and modernization policies. While other countries employed different mechanisms in implementing this consensus, the overarching aim of monetary institutions serving social goals was broadly shared across developed countries in the postwar era, as it had been during the 19th century during the infancy of central banks.

This consensus of central banks undergirding fiscal policy fragmented and fell apart from the 1970s onwards. The experience of stagflation, the increasing influence of financial institutions in policymaking, as well as a growing academic consensus on the dangers of central bank collusion with governments, dismantled both the expansionary fiscal state and the subservient central bank. The “Volcker revolution” in the United States was a first step in the gradual, post-Nixon institutionalization of a price stability-focused, independent central bank. The Bank of England was granted operational independence in 1997 by Labour Chancellor Gordon Brown, while the ECB has been independent since its inception in 1998.

The current paradigm of independent, inflation targeting central banks thus obscures the messy history of central banks as public institutions. Since their inception, monetary authorities have performed various different roles; while they served as guardians of price stability in Victorian England, they have originally served as developmental and fiscal agents for expansionary states, and have frequently continued to do so in the centuries since. Treating central bank independence as an ahistorical best practice approach is misleading, and we should recall that there have been alternatives to the current framework. As some have heralded the end of the era of central bank independence, while others have underscored the benefits of re-politicizing monetary policy, it is worth bearing this history in mind.

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13 comments

  1. knowbuddhau

    Amazing. I hadn’t heard. Sometime in the 90’s, an apolitical space opened up and the Fed moved right in. (And it alone? No, wait, the “intelligence community” is in there, too. Maybe others, I’m blinded by the light. Or something. Odd that it has a revolving door.) 30 countries, all of whom somehow independently, I presume, “decided” to adopt the same policy. The effect sounds familiar coughIMFcough.

    And what have the results been? Pure domestic tranquility and general welfare, I presume. How could 30 “independent” central banks be wrong?

    It’s just like when (almost) all the tribes of North America “decided” to move onto often rather inhospitable lands. They signed the treaties, after all.

    With an appeal to history at the end, at least some mention of “TINA, or else” would help contextualize economics in politics.

    Seriously, how is this “political independence” supposed to work? It’s like LEOs claiming their officers always act without any prejudice of any sort, especially when there’s a shooting involved. On what planet, in what dimension?

    Has the Nobel committee been notified? I’ll bet that fake one, just for economics, should be all over this, right?

    They are, of course inescapably political, since they’re a *central part of a political economy. You know you’re in deep, Lao-Tzu is said to have said, when you have to say things that should go without saying. That it works like a charm is at least as disturbing.

    Thieves, acting under the color of law, even with all the trappings of office in the world, are still thieves. Knowing that, easy marks should stop being so easy.

    Our government, our money, our banks. Why complicate things? (Looking at you, Hamilton.)

    Reply
    1. JTMcPhee

      “Of course there’s class warfare. My class, the rich class, is waging it. And we’re winning!” (Sometimes rendered as “And we’ve won!”) Per Warren Buffett, not to call us mopes aux armes, but to remind us where the power lies. The ratchet apparently only turns one way, even, as Matt Taibbi points out in the linked piece from Rolling Stone, when the “malefactors of great wealth” are shown up for what they are and what they have done and what they get away with still doing and will, on into a future when their predations have killed off most of us humans and most of the habitability of the planet. (I know, “don’t be so dang cynical, and stop embracing futility like a succubus lover, it’ll all come right in the end…”)

      “Our” government? Nope, not even close. “Our” money? Nope. “Our” banks? Nope. Not unless that indefinite “we,” that longed-for, often-invoked, collectively chimaerical Messiah of Change, kind of get together around an organizing principle and start doing the stuff that might invigorate some homeostatic activity of the political economy, particularly the equivalent of the immune system (and just the sniff of such huddling will bring in the agents provacatuer and the Sauron gaze of the Panopticon’s Third — of Five — Eyes…)

      Reply
      1. knowbuddhau

        Thanks for the uh, encouragement? May I suggest decaf?

        Conceptually speaking, in the context of first principles around which to organize a government, yes, they are.

        That they’ve been stolen, as you point out, further supports that assertion. TPTB have stolen and our eating our patrimony like gluttons, right in our starving faces. Do you suggest we just sit here?

        I mean really, Mr. Wet Blanket. Since we’re all dead in the long run anyway, why bother? Your word count betrays you, amigo.

        Reply
    2. knowbuddhau

      Compromise of 1790

      Historian Max M. Edling has explained how assumption worked. It was the critical issue; the location of the capital was a bargaining ploy. Hamilton proposed that the federal Treasury take over and pay off the debt states had incurred to pay for the American Revolutionary War. The Treasury would issue bonds that rich people would buy, thereby giving the rich a tangible stake in the success of the national government. Hamilton proposed to pay off the new bonds with revenue from a new tariff on imports. Jefferson originally approved the scheme, but Madison had turned him around by arguing that federal control of debt would consolidate too much power in the national government. Edling points out that after its passage in 1790, the assumption was accepted. Madison did try to pay speculators below 100%, but they were paid the face value of the state debts they held regardless of how little they paid for them. When Jefferson became president he continued the system. The credit of the U.S. was solidly established at home and abroad, and Hamilton was successful in signing up many of the bondholders in his new Federalist Party. Good credit allowed Jefferson’s Treasury Secretary Albert Gallatin to borrow in Europe to finance the Louisiana Purchase in 1803, as well as to borrow to finance the War of 1812.[14]

      A fair recap? Not my areas.

      Reply
      1. Wukchumni

        A great book on the topic is:

        “Hamilton’s Blessing: The Extraordinary Life and Times of Our National Debt” by John Steele Gordon.

        Reply
    3. knowbuddhau

      Ellen Brown has an interesting article out on this topic. Found it here.

      The problem with the Reichsbank, said Werner, was its excessive independence and its lack of accountability to German institutions and Parliament. The founders of post-war Germany changed the new central bank’s status by significantly curtailing its independence. Werner wrote, “The Bundesbank was made accountable and subordinated to Parliament, as one would expect in a democracy. It became probably the world’s most successful central bank.”

      But today’s central banks, he said, are following the disastrous Reichsbank model, involving an unprecedented concentration of power without accountability. Central banks are not held responsible for their massive policy mistakes and reckless creation of boom-bust cycles, banking crises and large-scale unemployment. Youth unemployment now exceeds 50 percent in Spain and Greece. Many central banks remain in private hands, including not only the Swiss National Bank but the Federal Reserve Bank of New York and the Italian, Greek and South African central banks.

      “An unprecedented concentration of power without accountability.” It’s not just a bank, it’s a weapon. But I’m sure we can trust them with it, this time.

      Reply
  2. Thuto

    “Independent central banks” has become an oxymoron. The people running central banks are as intellectually captured by the neoliberal imperative as any other, and central banks have become at once both enablers and defenders of the neoliberal status quo.

    Reply
  3. bruce wilder

    Well that was certainly a breezy tour of central bank politics, but I am wondering why, if the point was simply that the current fad for “independence” is just another phase in a long history, it had to go on as long as it did, or employ so much careless atheoretical phrasing.

    Central banks are an important example of an emergent institution. People invented them and then discovered, often thru dramatically difficult experience, what they were good for and how they had to operate; a consensus in their favor, let alone a consensus in favor of a single regime paradigm as in the current neoliberal prescription for “independence” and a primary focus on disinflation, has not been the historic rule.

    This essay would have been more difficult to write, but easier to read, if it had not shied so conspicuously from the role of disastrous mis-steps in central bank emergence. The BoE was founded in response to the catastrophe that followed on the Great Stop of the Exchequer and the BoE achieved its position of dominance in the resolution of the South Sea Bubble, absorbing the much larger franchise in national debt granted that infamous company. A parallel crisis in France, resolved less creatively without instituting either a central bank or a sensible fiscal system would set the ancien regime on course to destruction.

    The gold standard, referenced ahistorically in the essay, was itself an emergent system over the course of the 19th century, entangled with that now half forgotten state institution, the Mint, which dominated so much of economic policy-making in the 18th thru the 19th century.

    Competitive storytelling has been a critical weapon in the political struggles shaping emergent institutions. Gold, whatever the often painful reality of policy consequences, had a good story. Central banks, with their mysterious airs, often seemed to fail in the political art of storytelling. Nicholas Biddle was no match for Andrew Jackson. John Law may have been too good a storyteller for his own good and the good of France.

    Henry Thornton and Walter Bagehot, excellent storytellers, had a profound effect in shaping the role the central bank as lender of last resort. Carter Glass, founder of the Federal Reserve System, which is theoretically open to popular democratic control, was remarkably astute.

    “Independence” is a story, a myth. It does not need to be refuted in order to be overcome, so much as simply recognized as a lie convenient to certain ideological interests, even while the actual functions of a central bank in stabilizing the economic system and promoting positive activity are rediscovered. “Independence” is just the latest in a long series of errors waiting to be corrected as we learn from our mistakes.

    Reply
    1. knowbuddhau

      Yes, it’s a myth, but a myth is a metaphor, not a lie. It’s suggests a way of being in the world.

      This propaganda suggests to me a disinterested, priestly caste overseeing the arcane operations of a system we’re all familiar with, in our profane little lives, but none so well as they, so it’d be best if we leave the Brahmans of finance to themselves. Their enrichment and our simultaneous impoverishment is as purely natural and unavoidable as the weather. They’re just doing God’s work the best they can under stresses we can’t imagine. Or something.

      Or are we supposed to believe they’re the Vulcans of Wall Street? See, the universe is a mechanism, and so is society, so it’d be best to leave its functioning to independent technocrats, right?

      Myths, as metaphors, not lies, can be revelatory or deceptive, depending on the their use. They bypass the intellect and go straight to the heart, when effective.

      Like advertising, they don’t have to make sense on close examination. They just have to move the product. See also maya. in the sense of the power of illusion. Depends on your intention.

      Everybody’s in such a rush to bust myths, they overlook their tremendous soft power.

      Reply
    2. knowbuddhau

      And I’m always in a rush to defend them. Pardon my enthusiasm.

      You say, people invented them, and then found out….? As if they had no idea what they might do with all the People’s money, and as little accountability as politically possible, from the start?

      As if they were tinkering in a garage and had no idea what they’d done. I’m sure Hamilton had no idea what would become of his bank, either. He was just tinkering?

      I get your point: complex systems have unintended consequences, and there’s learning involved. But central banks didn’t just pop up one day in some tinkerer’s garage. What was the intention? “Promoting the general welfare, etc?” Or concentrating wealth?

      Reply
  4. RBHoughton

    “This consensus of central banks undergirding fiscal policy fragmented and fell apart from the 1970s onwards” – and the reason is largely down to one man. Read Ian Fraser’s autobiography “The High Road to England” for an account of how the Eurodollar market was created to disable the Bretton Woods agreement and return control of the money supply to private bankers.

    Reply
  5. steelhead23

    There is an obvious connection between the fiscal actions of the state and inflation and thus central bank policies. For example, were the state to increase spending at a greater rate than production, inflationary pressures would increase. The state could increase taxes – but if it didn’t the central bank could slow down the velocity of money by increasing interest rates, etc. Thus, independence in decision making makes sense and because the modern market is an arbitrage casino, secrecy until the moment of action also makes sense. What seems missing is trust and when the high priests of finance have presided over a disaster in the recent past – with another in the wings, it will take a very long time before the public trusts them again.

    Reply

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