June 29, 2016
The creation of central banks, as we know them today, can be traced to the seventeenth-century Europe. But before going into details first it would be good to discuss some elements that explained the rise of these institutions, which are responsible for governing the economic policy of most countries of the modern world.
As we described in our previous articles on the history of money and banking history, before there were central banks, commercial transactions were made with notes and coins issued by private banks –i.e., deposit certificates in gold issued by goldsmiths and small depository institutions. The circulation of these notes was largely guaranteed by the confidence the people had in these first banks. However, this system had some inherent risks; the most obvious was that the bankers could not meet withdrawal requests. This happened frequently at first, which eventually led governments to regulate the amount a given bank could lend against its capital, giving rise to the first banking regulations.
Because of the constant wars between European states of the time, governments (or kingdoms) were in continuing need to finance their military expenditures and, to avoid doing so via higher taxes, some rulers decided to grant special rights (or monopolies) of issuance to private banks which issued their State-guaranteed papers. The credibility and popularity these banks began to gain was such that even other private banks decided to become their clients and began to use their notes; equally important companies used these banks as lenders of last resort. Eventually, this caused the bank to which the ruler had given special license to become the largest in the nation and its notes were the most desired by the population, giving rise to large domestic banks, which became in what we know today as central banks.
From the seventeenth century to the early twentieth century, financing of wars and the role of lender of last resort were the main tasks performed by European central banks. The continued funding of State deficits generated inflation and financial crises in most of the European nations of the time. For example, the first central bank was created by the Swedish Parliament in 1668, with its main creditor being the Swedish Crown. Then the Bank of England, founded by Scotsman William Paterson in 1694, financed the struggles of William of Orange against Louis XVI of France, and later the struggles between England and the American colonies. In 1720, the Bank of England takes on the role of lender of last resort for the purpose of preventing the collapse of the South Sea Company, a public-private company that had a monopoly to market between South America and England.
CENTRAL BANKS BEFORE THE XX CENTURY
|England||Bank of England||1694|
|France||Banque de France||1800|
|Finland||Bank of Finland||1811|
|Austria||Austrian National Bank||1816|
|Portugal||Banco de Portugal||1846|
|Belgium||Belgian National Bank||1850|
|Spain||Banco de Espana||1874|
|Japan||Bank of Japan||1882|
Other central banks in Europe were created for the same purpose. The Bank of Spain began as the National Bank of San Carlos in 1782 to finance the American War of Independence, and although it was not a public bank, enjoyed the protection of the Crown and had close financial ties to the State. The Bank of France, founded in 1800, was created to finance the Napoleonic War. The Bank of Germany, known as Reichsbank, was one of the rare exceptions of the time since, despite being subordinate to the government, its legislation banned providing financing to the State. However, this rule was violated with the onset of World War I in 1914, a fact that caused that Germany was among the countries with the highest hyperinflation in the economic history of mankind. Despite this bitter experience, the Bank of Germany made the same mistakes of financing deficits of Adolf Hitler’s government, and this process is not stopped until 1957, when the Bundesbank replaces the old central bank. Since then, the Bundesbank has been one of the most powerful central banks, whose experience was the basis for creating and putting to work the Monetary Union of Europe. Perhaps inflationary experiences explain, to some extent, the fact that the Bundesbank is today the Central Bank with the more conservative monetary policy of the European central banks.
The role of central banks as policymakers arises from the Great Depression of 1930 that hit the United States and much of the European nations. Following the writings of John M. Keynes and the rise of macroeconomic theory, central banks are responsible for implementing monetary policies to grow the economy and achieve full employment. This, along with the contributions of Phillips (1958) and Okun (1962), are the technical arguments for economic interventionism of the twentieth century.
In its role as policymakers, central banks have traveled the path of having a multiplicity of objectives –some opposed to each other such as promoting development and full employment, regulators of the money supply, among others, to focus on a simple goal: price stability. Most modern central banks no longer incur the task of finance State deficits, a fact evidenced by the disinflationary process seen in the world since the early 1990s. Central banks are institutions respected by most of the citizens of most countries in the world because of the level of professionalism which characterizes its staff member.
Finally, we do not finish this article without mentioning the Central Bank of the United States: the Federal Reserve (Fed). This Central Bank is one of the most recent, because its history dates from the early twentieth century. However, given the special characteristics of the Fed, consisting of a central banking system, we leave the telling of its history for an upcoming article.