Bank of England

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The Bank of England is the central bank of the United Kingdom. It acts as the government’s bank, regulates the money stock growth rate and the availability of credit, and serves as a banker’s bank for commercial banks, making loans and holding deposits. Like all central banks, it holds the exclusive privilege to issue bank notes (paper money). Sometimes referred to as the Old Lady of Threadneedle Street, the Bank of England sits at the center of the London financial center.

The English Parliament granted the Bank of England a corporate charter in 1694 when England was waging a costly war with France. The government needed money, and the Bank of England began as a plan to help raise funds for the government. Parliament imposed a tax on shipping tonnage, and earmarked the proceeds to go to such persons as should voluntarily advance money to the government.

The government planned to borrow 1.2 million pounds at a moderate 8 percent interest. To attract funds on the scale needed at that interest rate, Parliament granted the subscribers to the loan the privilege of pooling their funds and incorporating themselves under the name of the Governor and Company of the Bank of England. The debate in Parliament over this act raised quite a howl, including predictions that the Bank would encourage fraud, gambling, and the corruption of national morals.

Initially, Parliament granted the Bank of England a charter for 10 years. This charter authorized the bank to trade in gold, silver, and bills of exchange, and to issue bank notes equal in amount to its capital. It prohibited the bank from selling merchandise, excepting what had been held as security for unpaid loans. The charter put the management of the Bank of England in the hands of a governor, deputy governor, and 24 directors, elected yearly by the stockholders.

Parliament continued to renew the bank’s charter, usually in return for loans to the government, often at lower interest rates. Parliament renewed the bank’s charter in 1709 and added a provision that no other joint-stock company with more than six partners could issue bank notes, a provision that eventually gave the Bank of England a dominant position in the issuance of bank notes. In 1751 the bank took over the administration of the national debt, and by 1780 the bank had a virtual monopoly on the issuance of bank notes in London. The Bank of England began to wear the aspect of a central bank as smaller banks began the practice of keeping funds on deposit with it.

Originally conceived to raise money to fight a war, the bank underwent a particularly innovative period of development during the wars with revolutionary France and Napoleon. Over the protests of the bank’s directors, the bank was forced to accommodate the financing needs of the government for unlimited amounts. The bank began issuing notes in much smaller denominations, and in 1797 the bank, with approval from Parliament, suspended the convertibility of its bank notes into specie. Government borrowing had weakened the bank’s reserve position and bank note holders were making a run on the bank. Even though they were now inconvertible, the value of Bank of England bank notes stood up well because the government accepted them at par value in all payments and in 1812 made them legal tender. Country banks began to hold Bank of England notes as reserves for their own bank notes.

After resuming convertibility of its bank notes into specie in 1821 the Bank of England saw its bank notes grow in acceptability relative to gold. The country banks found the notes just as useful as gold for managing a cash drain, and began to look to the Bank of England as a place to borrow funds in a liquidity crisis. In 1833 the British government again declared Bank of England notes legal tender for sums above 5 pounds so long as the notes remained convertible. As Bank of England notes replaced gold as the circulating medium, the bank became the major holder of gold reserves.

At first the Bank of England resisted the pressure to become a lender of last resort in financial crises, still seeing itself as a bank competing with other banks, rather than a source of succor to competing banks in a financial crisis. The bank discovered, however, that adjusting its bank rate of interest to compete with other banks destabilized markets. After the crash of 1847 the bank began accepting its role as a lender of last resort and using adjustments in its bank rate of interest to stabilize money markets.

The years preceding World War I saw the bank become the custodian of the gold standard, and develop methods of using the bank rate of interest and open market operations to regulate interest rates, and the inflow and outflow of gold. During World War I the government outlawed the export of gold, and after