1.1 The Emerging Public Interest in “Central Banking”
The paradox is that although no generally accepted definition of a “central bank” seems ever to have existed, everybody will recognize a “central bank” when they see one. However, the question could very well be asked if they are banks at all, or whether or to what extent they are just special government offices staffed possibly by a few bankers, countless numbers of a peculiar type of economists, bureaucrats, and occasionally even politicians. This, of course, also raises the question whether “central banks” are really necessary. After all, the world did quite well (from an economic point of view) a long time before anybody had invented the term “central banking” or “central banks”. The answer is, of course, that the concept of a “central bank” has developed over time, and that the concept has, historically, differed considerably between countries.
Until sometime around the 1960s, there does not seem to have been much general public interest in “central banking”. What “central banks” did or did not do was almost exclusively discussed in a rather closed world of bankers, academics and government officials. Some public debate grew up in the late 1950s in connection with what has been called a “revival of monetary policy”. After several years of virtually unchanged rates of interest, some central banks reactivated the discount rate instrument. Still, the interest from the general public seems to have been limited.
When focus on “central banking” and monetary policies increased around 1960, it probably had much to do with two quite separate developments:
First, since the mid-1950s rates of inflation accelerated in most of the western world leading to increased and unpopular rises in mid- and long- term rates of interest. The Bank of England and the Federal Reserve Bank of the United States (FED) responded by raising their respective discount rates, the main policy instrument at that time. This was highly unpopular in the UK and other countries, where housing has mostly been financed with loans carrying variable rates of interest, and where changes in short- term rates therefore have a direct and immediate impact on people’s expenses. In Scandinavia (particularly Denmark), the interest increases were also noticed, but they had little impact, because fixed property has always (until fairly recently) been financed at fixed rates of interest with bond loans of up to 30 years maturity (before the early 1970s, even up to 60 years) supplied by mortgage institutions or––to a lesser degree––by savings banks. However, even if the central banks responded to accelerating rates of inflation, nobody at the time suggested that the central banks could be held responsible for whatever rate of inflation happened to materialize, let alone expected the central banks to “target” any particular rate of inflation.
Second, the publication in 1963 by Milton Friedman and Anna Schwartz of the seminal A Monetary History of the United States 1867–1960 no doubt triggered an intense interest in the causes and effects of monetary changes and therefore in “central banking”. The term “monetarism” had been born. Monetarism implied a new interest in monetary policy not only among specialists, but also among readers of other papers than the Financial Times and The Wall Street Journal.
Friedman and Schwartz placed a great deal of blame for the severity and duration of the American depression of 1930–33 on the FED. In the same vein, Alan Greenspan, chairman of the FED 1986–2006, was first praised for pulling the world out of the 1988–92 recession and thereby creating the glorious 1990s, but was later seen by some economists as at least somewhat guilty of the bubble of 2005–07 and the subsequent recession. By his own admission he “did not get it” until late 2005.1 As if by seeing the mounting problems earlier he could have prevented the madness of crowds and the resulting property bubble. Similarly, Ben Bernanke, Greenspan’s successor as FED chairman, has been seen as a pupil of Friedman and Schwartz with his monetarist efforts at dragging the USA out of that recession (by “quantitative easing”), in contrast to the FED’s inaction of 1930–31.
Since 2014 similar tactics have been implemented by the European Central Bank (ECB), which is expected to send Europe on a real growth rate of 3 % p.a. with inflation hitting precisely 2 % p.a., and with unemployment not exceeding 5 %. Signals of this nature are constantly being sent out, and the public is swallowing them eagerly. Since governments cannot deliver the results everybody wants, the central banks must step in to do it.
Since the late 20th century there seems to have been almost no limits to the miracles that central banks were supposed to be able to perform, or to the troubles for which they could be held responsible. They are expected to deliver precise results on all macroeconomic targets, including specific inflation, growth, and employment rates. Few observers question even the theoretical ability of central banks to deliver the expected results.
Ensuring stability in capital markets, including the prevention of bank failures and stable “asset prices”, all now seem to be regarded as not only natural tasks for central banks, but also achievable goals for these venerable institutions. To many observers, central banks seem to be almost almighty.
It seems tempting to paraphrase Oscar Wilde: “Really, if central banks do not set us a good example, what on earth is the use of them?”2
Yet, at the 1920 meeting of finance ministers et al. in Brussels the final communiqué recommended that countries which did not have a central bank establish an independent one as soon as possible in order to help maintaining orderly monetary conditions.
Of course, this communiqué did not specify the definition, nature, or character of a “central bank”, other than it should be “independent”.
1.2 Some Preconditions for Having “Central Banks”
For the idea of “central banks” to have any meaning, a few conditions have to be fulfilled:
First, a monetary economy has to exist. In Scandinavia, this was not generally the case until rather late in the 19th century. The process of monetization of the Scandinavian economies is difficult––if not impossible––to follow statistically, but some indications are available.3 In Sweden and Norway money circulation was probably very limited outside the coastal towns until the second half of the 19th century. In Denmark the process of monetization probably developed a bit faster and earlier than in Sweden and Norway because of a denser population and the proximity to Hamburg. However, until 1847 neither Denmark nor Norway could boast of more than one bank. The development in deposits with banks and savings banks can to some extent cast light on the degree of monetization of a country, and this development is demonstrated in Table 1.1.
Table 1.1
Deposits in Scandinavian banks and savings banks 1860–1915
Mill Kroners | Deposits with Banks | Savings Banks | Total | GDP | Deposits in per cent of GDP (%) |
|---|---|---|---|---|---|
Denmark | |||||
1860 | 13 | 56 | 69 | 464 | 15 |
1880 | 78 | 254 | 332 | 840 | 40 |
1900 | 310 | 582 | 892 | 1.323 | 67 |
1915 | 1.077 | 995 | 2.072 | 2.887 | 72 |
Norway | |||||
1860 | 16 | 44 | 60 | (480) | (13) |
1880 | 81 | 139 | 220 | 720 | 31 |
1900 | 311 | 306 | 617 | 1.115 | 55 |
1915 | 1.007 | 724 | 1.734 | 2.594 | 67 |
Sweden | |||||
1860 | 18 | 27 | 45 | 704 | 6 |
1880 | 247 | 146 | 393 | 1.233 | 32 |
1900 | 772 | 494 | 1.266 | 2.162 | 59 |
1915 | 1.999 | 1.113 | 3.112 | 4.710 | 66 |
In all three Scandinavian countries, hundreds of savings banks sprang up during the early decades of the 19th century, but they were tiny and primitive. Like elsewhere, the savings banks preceded the commercial banks.
The development of financial deposits is used here as an indicator of the degree of monetization of the economy. The figures show that monetization advanced rapidly during the second half of the 19th century, and that there were some, but no sharp differences between the Scandinavian countries in this period. These macro figures cannot, of course, disclose the difference in the degree of monetization between the major cities, the harbour cities, and the inland provinces. In the inland provinces, barter economy was common until late in the 19th century, at least in Sweden and Norway. The type of economy referred to in footnote 3 was probably not confined to Finland only.
Secondly, paper money (bank notes) has to be widely circulating as the predominating means of settling cash payments.
Minting has, in virtually all Western countries, been a royal or a government prerogative since mints were first invented. The seigniorage has often been an important source of income for cash strained monarchs and governments. Coins remained the primary money supply long after bank notes had been invented, albeit with very large swings in both, depending on circumstances. As long as coins (of silver or gold) remained the basis of the money supply, the concept of “central banking ” was both impossible and irrelevant. Monarchs or governments minted coins, i.e. “real” money. Banks issued only paper money. The relative “weight” of paper money versus species is not a matter of statistics only. Rather, it is a matter of public sentiments and regulation. When paper competed with “real money”, paper money was usually subject to strict regulation regarding silver or gold coverage. Issuers of paper money issued only second-class money.
This was clearly demonstrated in the last quarter of the 19th century. Few, if any, politicians bothered...