Monetary Policy. Lender Of Last Resort;

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Money and BankingHistory of Central BankingFunctions of a Central Bank Sound currency and banking; Lender of last resort; Monetary policy.In history the functions developed in this order.1

Money and BankingHistory of Central BankingSound Currency and BankingSound currency and banking refers to two goals: Stable value for the currency; To prevent excessive lending and risk-taking by banks.2

Money and BankingHistory of Central BankingLender of Last ResortThe central bank acts as the lender of last resort to prevent abank crisis. In a crisis banks may contract their lending and themoney supply falls, which could push the economy intorecession or worse. For the central bank to increase its lendingto the banking system may then counteract this contraction.3

Money and BankingHistory of Central BankingMonetary PolicyMonetary policy to change the money supply or the interestrate may counteract recession or inflation.The idea that the government has the ability and the obligationto counteract the business cycle did not take root until after the1936 publication of Keynes’s General Theory of Employment,Interest, and Money [2].4

Money and BankingHistory of Central BankingBank of EnglandThe Bank of England—the central bank of the UnitedKingdom—was established as a profit-making companyin 1694. In exchange for making a loan to the new kingWilliam of Orange, it received a royal charter for banking.Using the bonds as backing, it issued bank notes, thus receivingboth the interest on the bonds and the seigniorage of the banknotes.5

Money and BankingHistory of Central BankingThe people gradually gained confidence in the bank notes, butoverissue was a problem at times. The Bank Charter Act of1844 regulated the note issue by the Bank of England.6

Money and BankingHistory of Central BankingThe Bank RateThe Bank Rate is the tool of monetary policy of the Bank ofEngland. It sets the Bank Rate, and the large banks can borrowfrom it at this interest rate. Consequently the Bank Rate setsthe market interest rate in the country.7

Money and BankingHistory of Central BankingFederal ReserveThe United States did not have a central bank until the FederalReserve was created by the federal government in 1913.8

Money and BankingHistory of Central BankingFirst Bank of the United StatesThe First Bank of the United States was a private bankchartered by the federal government for 1791-1811. The bankwas banker for the government, and policed the note issue ofother banks by presenting bank notes for payment in specie.The bank had political opponents, and the charter was notextended. One complaint was the concentration of power in thebank. Another complaint was its actions to keep moneysound—some preferred inflation.9

Money and BankingHistory of Central BankingSecond Bank of the United StatesThe Second Bank of the United States (1816-1836) was similar.10

Money and BankingHistory of Central BankingMoney Supply Not ControlledBecause there was no central bank, the money supply was notcontrolled: During the business cycle, the money supply wasprocyclical, up in the boom and down in recession; thepattern aggravated the cycle. The money supply did not vary seasonally. The moneysupply did not rise at Christmas, even though the demandfor money was higher then.11

Money and BankingHistory of Central BankingCentralization of PowerWhen the Federal Reserve was established in 1913, it wasanticipated that its power would be decentralized among thetwelve regional Federal Reserve Banks. The New York Fedwas the most powerful, since New York is the banking andfinancial center.During the Great Depression the power was centralized inWashington in the Board of Governors.12

Money and BankingHistory of Central BankingEarly Failures of the FedMany see the Fed as unsuccessful in its monetary policy.13

Money and BankingHistory of Central BankingRecession after World War IAfter World War I, the economy had a short but sharp recession1920-1921, and many banks failed.14

Money and BankingHistory of Central BankingStock Bubble of 1929In 1929 stock prices doubled from January to September, andthen crashed in October, falling 50%.The Fed took no action to counteract the speculation.15

Money and BankingHistory of Central BankingGreat DepressionThe bank panic of the Great Depression caused bank runs andbankruptcies. Half of the nation’s banks failed, and banklending contracted.The Fed failed to act as lender of last resort and the nominalmoney supply fell by a third.Although there is a chicken/egg controversy whether the bankpanic caused the Depression or resulted from the Depression,that the Fed acted weakly was a mistake. Many economistsbelieve that the Fed could have kept the recession starting in1929 from turning into depression.16

Money and BankingHistory of Central BankingReferences[1] John Kenneth Galbraith. Money: Whence It Came, WhereIt Went. Houghton Mifflin, Boston, 1975. HG231G35.[2] John Maynard Keynes. The General Theory ofEmployment, Interest, and Money. Macmillan, London,1936. HB171K45.17

Money and Banking History of Central Banking References [1] John Kenneth Galbraith. Money: Whence It Came, Where It Went. Houghton Mifflin, Boston, 1975. HG231G35. [2] John Maynard Keynes. The General Theory of Employment, Interest, and Money. Macmillan, London, 1936. HB171K45. 17

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