18 - The Puzzling Slow Rise of a Theory of Central Banking

Summary

Introduction

As the story told in this book has shown, monetary theorists from the mid-eighteenth century to the 1870s, with a few exceptions, focused on analyzing what they perceived as the preferred structure of the monetary system – a system founded on convertibility of bank notes to the precious metals – and how that system could best support the real economy. A critical issue – explicit or sometimes implicit – was the attitude of scholars toward interventions in the monetary system and in the financial sector more generally. The very idea of intervention contradicted, of course, the invisible hand approach to money and banking so typical of the founders of classical monetary theory, David Hume and Adam Smith. Hence, a detailed assessment of the few proposals in favor of intervention may help identify early thoughts about alternatives to the invisible hand – alternatives that came to be known in the twentieth century as monetary policy or central banking. One has to remember that, to the surprise of many modern economists, there was no accepted theory of central banking even as late as 1873, when Walter Bagehot first attempted to develop one with the publication of Lombard Street. We will argue in this chapter that his theory was not a fully developed theory of central banking. Such a theory had to wait for Knut Wicksell’s path-breaking 1898 text, Interest and Prices, and his later Lectures on Political Economy.