Major Developments

1

From the middle of the 17th century, England and London in particular, buzzed with ideas - indeed the era has been dubbed 'the age of projects' - but one which kept coming to the fore was the notion of a national bank. People sensed that the country was on the brink of a tremendous expansion of trade, but one vital element was lacking: what was needed was a bank or "fund of money" - more liquidity, in modern parlance - to drive the trade of the country. They looked with some envy across to the continent at the example of the Dutch who were then pre-eminent in Europe.

Central to the success of the Dutch was the Amsterdam Wisselbank, which had been founded in 1609. It provided the motive power for the Dutch economy by lending to the City of Amsterdam, the State in the form of the Province of Holland and trade in the shape of the Dutch East India Company as well as being responsible for coinage and, of course, exchange. Much later, in 1683, it was empowered to lend to private customers. Payments over a certain amount had to pass through it and it therefore was convenient for the important finance houses to hold accounts with it. Thus not only was it in a position to oversee the Dutch financial scene, it was also able to act as a stabilising influence on it.

2

Calls for a National Bank in England
In England the argument for some kind of bank to gather momentum after the Glorious Revolution of 1688 when William of Orange and Queen Mary jointly ascended the throne of England. The political economist Sir William Petty had recognised from the example of the Dutch that successful credit- based trading could benefit a nation in many ways and help to enlarge its sphere of influence: he wrote in 1682 "What remedy is there if we have too little money? We must erect a Bank, which well computed doth almost double the Effect of our coined Money; and we have in England Materials for a Bank which shall furnish Stock enough to drive the Trade of the whole Commercial World".

Dutch William had brought to his adopted country an understandable desire to help his native country in its war against the French and this proved to be the catalyst necessary for the idea of a national bank to be accepted, albeit grudgingly by some.

But it took a London-based Scots entrepreneur, William Paterson, to propose the scheme that eventually found favour: his first, proposed in 1691, had been rejected for several reasons. This was partly because, as he wrote in 1695, "Others said this project came from Holland and therefore would not hear of it, since we had too many Dutch things already". Under his scheme, in return for a loan of £1 million, the bills issued by his company should be made legal tender. This idea proved to be more than a century ahead of its time, and consequently unacceptable to the Parliamentary Committee.

'A Fund for Perpetual Interest': The funded National Debt is born
After several more rejections Paterson put forward a plan for a 'Bank of England' and a 'Fund for Perpetual Interest' although this time bills were not mentioned. Supported by two powerful personalities - Charles Montagu, Chancellor of the Exchequer, who looked after the Parliamentary lobbying, and Michael Godfrey a leading merchant who ensured the ideas acceptance in the City - it was all but inevitable, given the Government's pressing need for funds, that the scheme should be approved by Parliament. So Paterson's plan was accepted and the necessary Act passed. The public were invited to invest in the new project and it was these subscriptions totalling £1.2 million that were to form the initial capital stock of the Bank of England and were to be on-lent to Government in return for a Royal Charter.

The Government's immediate motive for creating the Bank was its pressing need for money - Paterson himself said that the Government accepted his proposal only as "a lame expedient for £1,200,000". And for some time afterwards the Government saw the Bank in that light - renewals of its Charter had to be paid for with loans, often painfully negotiated, from the Bank to the Exchequer. There was little in the Act creating the Bank to hint at what it would become - certainly no suggestion of a central bank, scarcely a hint of banking at all. But the Charter was enough. The Bank was big, it was incorporated with limited liability (extremely rare then) and it set out to take full advantage of this position.

To start with, the Bank was the Government's banker: managing the Government's accounts; managing (at some expenses to itself) the recoinage of 1696; providing and arranging loans to the Government. It was also a commercial bank, dealing in bills - the then equivalent of overdraft finance, furnishing finance for trade. It took deposits and issued notes, and with the development of the issue function it began to realise the dreams of some of the original projectors, of a Bank that would "double the Effect of out coined Money".

3

A credit-based economy
One particularly significant development around this time lay in the perception of credit or 'imaginary money' as it was then called. It represented a fundamental and distinctive principle in the new thinking that was so prevalent during this age of ideas and experiments. Projectors had begun to recognise the existence of an untapped source of assets, albeit non-metallic, such as stocks of merchandise, tax receipts, revenues on land and commercial obligations, against which 'credit' or 'imaginary money' could be raised. Credit could be, they argued, the seed corn of wealth. But what was the money? To the man in the street, money simply meant coins, but the new thinking was overturning that Shibboleth: it was suggesting that money could take other forms which would have no intrinsic value and yet still possess qualities to enable it to be used to make payments thereby fuelling and lubricating the economy. It was inevitable, therefore, that when theory became practice and the funded National Debt was born that crucial element, paper money, almost simultaneously completed the equation.

Banker to Government
The 18th century was a period dominated by governmental demand on the Bank for finance: the National Debt grew from £12 million in 1700 to £850 million by 1815, the year of Napoleon's defeat at Waterloo. Reliance by government on the Bank had developed to such an extent that at the renewal of the Charter in 1781 the Prime Minister, Lord North, described the Bank as "from long habit and usage of many years………a part of the constitution", and that it was "………to all important purposes the public exchequer". North went on to explain that "……..all the money business of the Exchequer" was "done at the Bank, and as experiences had proved, with much greater advantage to the public, then when it had formerly been done at the Exchequer."

Eventually, though, prudence and discretion proved insufficient. The Bank was the nation's bank, and at times of natural crisis its gold reserve was needed for national purposes.

4

Monetary indiscipline leads to inflation
The wars with France which began in 1793 and lasted some 22 years put an enormous strain on the nation's finances. In 1797 the Government was obliged to protect the gold reserves for the war effort by declaring the Bank's notes inconvertible. This 'Restriction Period', as it was known, continued for six years after the end of the war, until 1821. Because of the consequent shortage of coin the Bank issued £1 and £2 notes to keep the wheels of trade turning; but, inevitably, prices rose generally and this provoked a fierce debate and the setting up of a Parliamentary Select Committee which attributed the country's difficulties mainly to the Bank's over-issue of paper. The Committee argued that a paper currency which had ceased to be convertible into gold or silver coin could only be kept up to its proper value by limiting its quantity, in that way it would become again a sound currency. Monetarism was born.

There were many small banks issuing notes at this time and by no means were all of them sound. The hard time road to monetary discipline, which followed the return to convertibility, inevitably led to the failure of many of these partnerships which had irresponsibly expanded their note issues. The Bank of England's difficulties were neatly summarised in 1830 by William Cobbett, who could never be described as a friend of the Bank: he wrote "The Bank is blamed for putting out paper and causing high prices; and blamed at the same time for not putting out paper to accommodate merchants and keep them from breaking, It cannot be to blame for both and indeed is blamable for neither. It is the fellows that put out the paper and then break that do the mishchief".

The Country Bankers Act, a milestone in the development of banking in England, was passed by Parliament in 1826. It breached some of the Bank's former privilege by permitting the establishment of joint-stock banks with more than six partners but not within 65 miles of London. The Act allowed the Bank to establish branches in the major provincial cities from which it was able to increase its sphere of influence by sound note issue. In 1833, the Bank's notes were made legal tender for all amounts above £5, ensuring that in the event of a crisis, as long as the credit of the Bank remained good, the public would be satisfied with its notes and its reserves would consequently be safeguarded.

The Gold Standard: the Bank's notes backed by gold
Regarded by some as the first move towards nationalisation, the 1844 Bank Charter Act was also the key step towards the Bank achieving the monopoly of the note issue. There were to be no new issuers of notes and those whose issues lapsed, or who were taken over, forfeited their right to issue. But the crucial clause of the Act was a monetary one: it provided that beyond the Bank's capital of £14 million, its notes were to be backed by gold coin or bullion. This, together with a fixed price for standard gold, laid the foundation for the gold standard which, during the nineteenth century, spread worldwide and created a long period of price stability with monetary policy, in effect, on auto-pilot.

Bank assumes responsibility for financial stability
Monetary stability alone, however was not enough. There were, of course, crises and in order to prevent systemic collapses the 1844 Act had to be suspended: this occurred in 1847, 1857 and in 1866 when Overend Gurney, one of the most prestigious City houses failed. Walter Bagehot, the celebrated editor of the Economist wrote in 1866 about the Bank's part in the crisis of that year that the Bank held, should hold and should be responsible for holding "the sole banking reserve of the country". If the Bank had been slow to recognise its responsibility for financial stability in earlier cases, its reaction in 1890, when Baring Brothers were threatened, heralded a new era in the Bank's stewardship of the Square Mile. A rescue operation in the form of a guarantee fund was orchestrated by the Governor of the Bank and more than £17 million was promised, much of it from the by now powerful joint-stock banks. The crisis was averted but the leading role played by the Bank demonstrated the responsibility it had come to feel for the stability of the banking system as a whole.

The Bank's second century had thus seen the two key elements of central banking emerge - the concern for monetary stability, born during the inflationary excesses of the Napoleonic wars; and the responsibility for financial stability, developed in the banking crises of the mid-19th century.

5

 1931: Britain off the Gold Standard
As with the French wars a century before, the First World War saw the link with gold broken and the issue of low denomination notes once more. A vain attempt was made in 1925 to return to the discipline of the gold standard but it failed and in 1931 the United Kingdom left the standard for good. The country's gold and foreign exchange reserves were transferred to the Treasury although their day-to-day management was and still is handled by the Bank. The note issue became entirely fiduciary, that is to say not backed by gold.

During and after the war internal changes began to take place at the Bank, presaging the modern Bank. The Governorship, which had until then generally been held for two years only, and then sometimes on a part-time basis, became a full-time professional post. Lord Cunliffe served for five years; Montagu Norman for twenty-four. Specialists were recruited to the staff. Relations with overseas central banks were built up. During Montagu Norman's governorship (1920-44) the Bank deliberately moved away from commercial business and increasingly assumed the role of a central bank. Assistance was given in the rationalisation and redeployment of a war-based economy to one which might help to rebuild war-ravaged Europe, and Norman was one of the leading players in the establishment in 1931 of the Bank for International Settlements - a forum for central bankers - in Switzerland.

And the relationship with the Treasury changed. The funds which the Bank was deploying in its operations in the market were increasingly public funds. As noted earlier, the gold and foreign exchange reserves passed to the Treasury in 1931. Norman once famously remarked that he was "the instrument of the Treasury".

1946: Bank of England nationalised
Nationalisation, after the Second World War, therefore made little immediate practical difference to the Bank. It shifted final authority over monetary policy to "the other end of town", but that tendency had been established years earlier. The Bank remained the Treasury's adviser, agent and debt manager.

During and for years after the war it administered exchange control and various borrowing restrictions on the Treasury's behalf.

The cheap money policies in the 1930s persisted for some years after the war, but during the 1950s and 1960s (partly under the influence of the Radcliffe Report, but more importantly as a result of US academic work) there was a revival of interest in monetary policy. As the apparatus of post-war controls was gradually lifted, the need for an active monetary policy became more evident, and the serious inflation of the 1970s and early 1980s proved the catalyst for change. Monetary targets were introduced in 1976, and reinforced in the early 1980s. These proved unreliable as a sole guide to policy, but the consensus was clearly established: price stability is desirable in its own right and a necessary condition of sustainable growth; inflation reduces growth and has other social costs; inflation is a monetary phenomenon; and without appropriate monetary measures inflation cannot be properly brought under control.

Operational independence and regulatory reform
In 1997 the new Government announced its intention to transfer full operational responsibility for monetary policy to the Bank of England. The Bank thus rejoined the ranks of the world's "independent" central banks.  However, debt management on behalf of the Government was transferred to HM Treasury, and the Bank's regulatory functions passes to a new Financial Services Authority.