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The Bank of England's Mission and the Positive Money Proposals

John Singleton, March 2014

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Contents

• History of Bank of England

• Current functions

• How those functions would change under ‘Positive Money’

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Origins of Bank of England

• Created in 1694 to fund naval construction• London merchants & bankers lent gold to the

government in return for govt bonds (IOUs)• BoE was given the privilege of issuing bank

notes and became the government’s banker

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Origins of Bank of England

• From early 18th C to 1931 (with some wartime breaks) Britain was on the Gold Standard

• Bank of England notes were convertible into gold at a fixed rate

• BoE held large gold reserves• These gold reserves were the

bedrock of British money supply

Sovereign was a £1 gold coin. It always contained 7.3 grams of gold

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Lender of last resort

• In 19th C other banks found it safe and convenient to use accounts at the BoE

• BoE became a ‘central’ or bankers’ bank

• BoE acquired responsibility for helping the banking system out when it was short of cash

• Known as ‘lender of last resort’ function

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‘Dividend day at the Bank of England’,by George Elgar Hicks 1859

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Nationalisation

• Since Britain left Gold Standard in 1931 the pound has been convertible into … thin air

• 1946 Labour government nationalised the BoE but this made little practical difference

• 1998: Bank of England’s ‘independence’ was restored though it is still owned by the Crown

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Financial crisis 2007-09

• , The crisis saw the rescue of some major UK banks

This episode suggests that there are big problems with the monetary and banking systems

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Current functions of BoE

• 1. Monetary policy• Government sets an inflation target• Bank of England then adjusts interest rates to

influence spending in the economy and thus to manage inflation

• BoE does not attempt to control the money supply directly

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Current functions of BoE

• 2. Acts as banker to the government and the commercial banks (Lloyds, HSBC, RBS, etc)

• All of the above have accounts at the BoE which are in constant use

• Safe and convenient to bank at the BoE• (BoE does not provide accounts to individuals

or other types of business)

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Current functions of BoE

• 3. Supervisor of banks and lender of last resort to banking system

• If other banks are in difficulty they can borrow (i.e. get more money) from BoE

• Difficult for BoE to refuse because a big bank collapse would hurt the economy

• To reduce the likelihood of problems the BoE monitors (supervises) banks

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Current functions of BoE

• 4. Lender of last resort to the government

• Not a function the BoE would acknowledge

• In practice, though, BoE is the largest buyer of government bonds (IOUs) and the amount has grown rapidly during the crisis

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Pros and cons

• Monetary and banking system is messy and complicated

• Can be abused by the high street banks & government

• But at least there is a measure of decentralisation – nobody is in total control of the monetary and banking system

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Walter Bagehot

• , Walter Bagehot – the main authority on central banking in 19th C

Bagehot didn’t like the Bank of England, but felt it would be too difficult to change a system that existed and was widely accepted.

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Positive money proposals

• 1. Everyday bank deposits of individuals and ordinary businesses are now at the BoE

• These accounts would be managed by the high street banks, but depositors’ funds would not be at any risk if the bank failed

• (People could choose to have separate savings accounts at high street banks which are at risk)

• The government and banks would also have accounts at BoE)

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Positive money proposals

• 2. BoE would determine and create the entire money supply for the economy

• Its new Money Creation Committee would choose the figure that provided the best prospects for the economy

• MCC would ignore any pressure from government or lobbying from the private sector

• (Money supply is currently determined by several factors - and money is created by each high street bank as well as BoE)

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Positive money proposals

• 3. BoE would not be lender of last resort• Bank failures would not affect the everyday

accounts of its customers (deposits are at BoE)

• (But there would be losers:• As well as managing deposits, banks act as

finance companies investing customers' savings• Savings are in separate accounts NOT at the BoE• These savings might be lost)

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Nearly finished...

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Positive Money has merit, but• 1. Can the Money Creation Committee ever be

completely independent and beyond influence?– Proposal is to let MPs (!) choose most members– So how can it be independent?

• 2. Should anyone have so much power?• 3. How can MCC be sure what the best level of

money supply is?• 4. A bank failure could still hurt millions of

savers and borrowers. Will banks really not be bailed out?