Quote of the Day: October 24, 2011
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Monetary Constitution of the Eurozone Blogging: A History Lesson for the Grandees of the ECB

The Grandees of today's ECB bear a weighty responsibility. They need to carry it well.

A short history lesson should help them:

In the statutes of the mid-nineteenth century United Kingdom there was a law--7&8 Vict. ¶32--that expressly prohibited the Bank of England from expanding the country's high-powered money stock except as the consequence of a gold or silver inflow:

Be it enacted by the Queen's most Excellent Majesty, by and with the Advice and Consent of the Lords Spiritual and Temporal, and Commons, in this Parliament assembled, and by the Authority of the same... [that] it shall not be lawful for the said Governor and Company to issue Bank of England Notes... to any Persons whatsoever, save in exchange for other Bank of England Notes, or for Gold Coin or for Gold or Silver Bullion received or purchased for the said Issue Department under the Provisions of this Act...

Here we have the strictest black-letter legal prohibition against the Bank of England's acting like a proper central bank as a lender of last resort during a financial crisis.

Nevertheless, in the mid-nineteenth century the Bank of England did act like a proper central bank and did serve as a lender of last resort in financial crises. It did print up bank notes unbacked by any gold or silver bullion and did use them to buy dodgy and impaired securities from banks. It did so on three mid-century occasions: in 1847, 1858, and 1866.

How did the Bank of England dare break the law? How did it dare violate the express and direct command of its Dread Sovereign Lord and Excellent Majesty Victoria of Hanover, given with the Advice and Consent of her Lords Spiritual and Temporal, and Commons, in Parliament assembled?

The Bank of England got up the nerve to break the law in these three cases because the then-Chancellors of the Exchequer asked it to do so. In 1847 Lord John Russell, in 1858 Sir G.C. Lewis, and in 1866 William Gladstone wrote letters to the then-Governors of the Bank of England suspending the provision of the Bank Charter Act banning the Bank of England from issuing additional unbacked bank notes. From what place did Russell, Lewis, and Gladstone get their authority to countermand their Queen Victoria's commands? From out of thin air. They grabbed the power on the grounds that salus populi suprema lex, and then went and told Parliament what they had done.

John Ramsey McCulloch in 1858 http://tinyurl.com/dl20111024a explained why the mid-nineteenth century British ruling class thought that this spectacle--having the Chancellor of the Exchequer periodically beg the Governor of the Bank of England to break the law, and the Governor then doing so--was a good system:

The [Bank of England Charter] Act of 1844 is a rule to be enforced in all but extraordinary and unforseen emergencies, the urgency of which cannot be appreciated beforehand, but must be determined at the moment. But when theese occur, it may, like the Habeas Corpus Act be properly suspended. It is... not applicable [when] the convertibility paper into coin... [creates] a state of internal discredit or panic... its suspensions in 1847 and 1857 are... justified by the state of our domestic affairs making an adherence to principle inexpedient and impracticable....

Inasmuch, however, as the Act of 1844 has been suspended in caes of emergency, and as there can be no doubt that it will be supended if occasion require in tie to come... such suspension [could] be effected as hitherto by the pro re nata interference of ministers, or.... [by adding] a suspensive power... embodied in the Act. We believe, however, that the present plan [of extra-legal ministerial action] is much the best....

When government interferes to suspend the Act the necessity under which they are now placed of applying to Parliament for an indemnity, and the discussions thence arising, are the best securities that can be obtained for the measure not being resorted to rashly, or without a reasonably good cause. But it would be quite another thing did the Act contain a clause authorising suspensions. This would show that they were expected, and, indeed, almost invited. Under such circumstances, they would soon be regarded as matters of course, and to be resorted whenever a complaint or cry of monetary pressure was got up. And were such the case, it would be idle to suppose that either the Act or the convertibility of notes should be maintained for any considerable period. The millennium of the paper-mongers would be at hand. When the checks which with difficulty restrain over-issue, depreciation, and fraud, are repealed or rendered inefficient, what are we to expect but that they should extend their baleful influence on all sides?...

[T]he Act of 1844 should be indefinitely continued with little or no alteration. We are well-convinced that all the most important interests of the country will be best secured by such a proceeding...

The Grandees of today's European Central Bank claim that the terms of their charter prohibit them from acting to promote any objective other than a rate of consumer price increase in the eurozone of less than 2% per year.

The implications of this short history lesson for the Grandees of today's ECB are obvious.