Dan Snow's History Hit - A Short History of the Bank of England

Episode Date: September 26, 2022

As the UK's bond market has suffered its biggest fall in decades and the pound has reached its lowest ever price against the US dollar, Dan talks to Dr Nuno Palma, a senior lecturer and associate professor in economics at the University of Manchester about the Bank of England. Dr Palma explains its historical role in Britain's imperial expansion and the industrial revolution and now how it's fighting to keep the British economy from the precipice.This episode was produced by Beth Donaldson, the audio editor was Dougal Patmore.If you'd like to learn more, we have hundreds of history documentaries, ad-free podcasts and audiobooks at History Hit - subscribe to History Hit today!To download the History Hit app please go to the Android or Apple store.Complete the survey and you'll be entered into a prize draw to win 5 Historical Non-Fiction Books- including a signed copy of Dan Snow's 'On This Day in History'.

Hi everybody, welcome to Dan Snow's history hit. The pound has reached its lowest ever price against the US dollar. The UK's bond market has suffered its biggest daily fall in decades. It's now expensive for the UK government to borrow money. It's all looking pretty rough. The perfect time, I thought, for a little economic history, folks. A little financial economic history. We're talking to Dr Nuno Palmer. He's a senior lecturer. He's an associate professor in economics at the University of Manchester. And he has written a lot about the Bank of England, its founding and its role in the long course of British history, from underpinning

British military and imperial expansion to the Industrial Revolution. There is no better time to catch up with Nuno about the Bank of England as the bank fights on several fronts to keep the British economy from the precipice. It's a really important bit of history, this. As he describes it in the podcast, the Industrial Revolution could be the most important. It's a really important bit of history, this. As he describes it in the podcast, the Industrial Revolution could be the most important thing that's ever happened in recorded history. And the Bank of England had its fingerprints all over it. What was the Bank of England? What is it now? What's it been doing for the last 300 years? All your questions answered in this podcast. Enjoy.

Nuno, thank you very much for coming on the podcast. Thank you very much for inviting me. What is going on in the 1690s? Why is the entire English and British financial system undergoing revolution? Well, there has just been the glorious revolution. Part two of the great constitutional changes that happened in 17th century england uh apparently in this country you guys did it all in the 17th century so you never had to do proper revolutions again and like all the other european countries and in the wake of the glorious revolution many things happen one of which is the founding of

the bank of england okay and the bank of england it now is independent again but it's become known as a central bank it's seen as an organ of the state of government it doesn't begin like that does it it's got lots of investors who are closely connected with the government including the king and queen what is the idea behind this bank? So absolutely. I mean, the Bank of England was only nationalized after World War II. Until then, nominally, at least, it was a private institution for the benefit of the shareholders.

However, from a very early date, I would argue from its foundations, it acted in ways that were closely aligned with the interests of government. So in some sense, it was always an arm of the state. You know, we can look at what happened on the Industrial Revolution from many points of view. And the traditional story about the Industrial Revolution is that it was a story of entrepreneurship, free markets, innovation, nothing to do with government or the state. Actually, when you look a bit more closely, you see that there is a very symbiotic relationship between political institutions, including the Bank of England, and these great changes that would happen in the 18th century.

Definitely. And I want to come on to that. And that has an important resonance today as well, when people talk about the role of state and entrepreneurial activity. But originally this bank, why is it a different bank to Coutts Bank or Hawes Bank, where people put money in and are paid interest and that bank in turn loans money out? What is different about the Bank of England from its inception? loans money out. What is different about the Bank of England from its inception? It's very different from its inception. So even though the Bank of England also did private business, such as discounting bills for private individuals that is giving loans, it was always very much associated with lending money also to the state. And it was in what we would call in modern terms systemic. It also lent money to a lot of other banks. In the 18th century, you can think of the Bank of England in one sense as almost just the Bank of London. It did not have a lot of activity outside of London yet in the 18th century, but indirectly it did. For example, by lending money to banks that they themselves were established outside of London, the so-called

country banks, and also by lending a lot of money to the government, which indirectly affected the economy overall. You bet it did. The fiscal military state, we can come on to that as well. But I've been to the bank and I've seen its sort of founding documents. It was patriotic, wasn't it? There was a sense the king and queen led the subscription themselves and they invested their money. And it felt like it was patriotic, because what you were creating a kind of stable engine at the heart of the economy. And then also, you know, you got interest payments, put your money in the bank, and it lend loan to the government, you would do well out of that, would you? Yes, many people made money in that way. But in a sense, the Bank of England

also helped the government function properly and function in a more powerful way than other European states did at the time. We really see this as a symbiotic relationship that both sides profited from in some sense. And what's amazing about those founding documents is you've got the top, you've got the monarch and the aristocrats, and then you've got normal people investing just a few pounds here or there. You've got craftsmen and tradespeople. Anyone could deposit. Yes, although I wouldn't say it's the most typical investment that normal people would do. And for discounts, they would be rigorous about who they would discount to.

But yes, in principle, it was possible. The idea then, the government could then go to the Bank of England and borrow money at a reasonably low rate of interest, and much lower than the French government was paying for its debt. Yes, these loans were negotiated and the bank had a charter that had to be renewed every few years. Often when the charter deadline approached, the government would negotiate a new big loan and the Bank of England was wise to accept the terms. And it did. But in the end of the day, the government also knew that it was

profiting from this existing institution and that it was also in its interest that it would continue. The point is that, like you say, relative to other continental European countries, you know, I do a lot of comparative history. It was a big advantage to have an institution like that working. And you have to think of it, the bank, the market, the state, as a table with three legs, out of which if you took one out, the table would collapse. They really supported each other. And you have to think of the tremendous success that was 18th century British economy in comparative terms as a result of a symbiotic relationship between all these institutions and the market. So as you point out, the 17th century is chaos in the isles in Britain and

Ireland, Scotland, England. You get the bloodiest war per capita that we know about in recent history. we get several uprisings and revolutions, a king is killed, another king is chucked out. And yet, from the 1690s onwards, you get this explosion of British economic activity, cultural, scientific endeavour, and hard military power. And that's partly because the government are able to spend a lot of money, right? The Royal Navy is the best funded, to spend a lot of money right the royal navy is the best funded becomes the most powerful military force on the planet and the government is raising taxes a bit but it's doing that by long-term borrowing right and is the bank the mechanism

through which it's able to borrow from rich people both in britain and abroad yes it's a key part of it so like you said you know you can think of all those constitutional changes in the 17th century, including the earlier civil war and then restoration. And then the glorious revolution has changes that just created the right setting. There was a lot of destruction, but to use a Schumpeterian term, it was creative destruction. It was destruction that then set the right conditions for economic growth to take place. And for the Industrial Revolution, which you could argue is the most important event in recorded history to take place. And then this sets the foundations for modern economic growth.

And like you said, one foundation for that is imperial policy. And it was the capacity wage war. With one exception, Britain does not lose any major war in the 18th century. The only exception, of course, is the American Revolution. Everything else is only very minor things. And you can imagine that, for example, if a Napoleonic invasion of Britain had succeeded, then this revolution would have gone in a completely different direction. So, you know, understanding the foundations of why the state was able to provide even national defense matters for the economy because it matters to generate environment that is business friendly, let's say, that is low risk

and that in some way promises investors a good return on their investment. can in some way promise investors a good return on their investment. So, you know, this capacity of the government at any moment to wage war, to raise large amounts of revenue in times of emergency, especially when the market dries up, and especially in these moments where the market dries up, and hence, as a result, interest rates would shoot up, you know, having the Bank of England there to provide this liquidity,

to aggregate funds from many sources, to give credibility to the whole thing mattered a lot. Of course, just to finish, the Bank of England itself was able to do that because the government had a good measure of credibility too, thanks to those earlier constitutional changes. So, you know, these things have to be understood as a whole, right? Yeah, unlike the French government, the British government, their checks never bounced, right? There was a confidence that you could buy bonds, you could lend the British government money, and that you would get that money back. Whereas some European despot might change their mind, like earlier English kings,

like the Plantagenet kings of England, and you might lose the whole thing. Or even later than those, you know, in the 16th century, the Tudors could not borrow on long maturities in the international markets. You know, Gresham, who worked for Elizabeth the first tried, and no Italian would lend to them on long maturities. Up to the Civil War, there was no perpetuities issues in this country. And like, by the way, the Castilians or the Portuguese in the 16th century, which could issue long-term perpetuities at relatively low interest rates in the 16th century, but then no longer in later centuries. And England does exactly the mirror image of that. By the 18th century,

they could lend long-term. But this is, again, the result of the 17th century constitutional changes together with then these supporting institutions like the Bank of England that appeared. You're listening to Dan Snow's History. We're talking about the Bank of England, interest rates, the bond market. What's going on? More coming up. On not just the Tudors from History Hit, I'm off to Portsmouth to investigate the Mary Rose, Henry VIII's mighty warship which sank in the Solent in 1545. This was an enormous tragedy to the people of Portsmouth and certainly to the members of the Mary Rose's crew.

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wherever you get your podcasts. so let's talk about your ideas now about the industrial revolution and the bank is it a matter of direct sort of government spending so you look at someone like john iron mad wilkinson who is one of the sort of um pioneer of cast iron and iron founding in the Industrial Revolution. Like American microprocessors during the Cold War, a lot of the money is coming in from government, you know, defence contracts. So he's building his ironworks on the basis of selling cannon to the Royal Navy. That's public money coming in. Is that an important function of the Bank of England or is there a more direct role in the Industrial Revolution? There were different mechanisms through which it mattered. I mentioned earlier the funding of

government itself is one mechanism and that's not a negligible one. If there had been a successful invasion of England and in the Napoleonic period there was a risk of that, things could have gone a different direction. Building an empire, and I'm making no judgments, I'm not saying it's a good thing normatively, it's a bad thing. I'm just saying as a description of the world, building an empire provided investment opportunities as well. But that's not a free market story in some sense. Building an empire requires raw military power. And in the case of England, it required a strong navy especially. And this is And in the case of England, it required a strong navy, especially. And this is something that the Bank of England indirectly really helped the government do.

And then there was support to private entrepreneurs, investors as well. Now, what I just think is the wrong way to see this, and some scholars, some of my colleagues have looked at, you know, what for the time were enormous government expenses in the 16th century with military as a waste of money. But these government expenditures were not pure waste. They were not building toys and trolling me on the ocean. They are using this military power. And the way they are using this military power is in turn indirectly generating investment opportunities. So there's these different ways in which the Bank of England is helping the economy grow that go beyond the simple-minded story of, you know, the Industrial Revolution was some genius building some cotton

textiles with a factory that they just came up with the idea of putting together. It's more complex than that. We're talking against the backdrop of a sterling crisis and it seems to be a UK bond crisis as well. Now, Nuno, you've got to help us out here. What is the bank's role at this time? Well, the Bank of England has a mandate just like most modern central banks now have mandates and their rules are defined. These mandates, they change a bit from country to country.

For example, the European Central Bank, supposedly the mandate is only about controlling inflation. In the United States, the Fed is about stabilizing the economy in terms of unemployment. I'm not sure about what the details of today's Bank of England mandates precisely, but essentially they are always concerned with stabilizing the economy and controlling inflation today. I think honestly that, and this is, you know, quite a personal view, so I don't put this responsibility on anyone, but I do think that central banks need to reflect on the deeper influence they're having on society. Because what you learn

in macroeconomics is that money can only affect the economy in the short term. But I actually think that's not true, that money in certain conditions, the way you run monetary policy, can affect long-term outcomes. Today, when you have a central bank that keeps stabilizing the economy, even when people make very bad choices, such as Brexit, might not be a good idea because it might make people, they don't feel enough the consequences of the choices that they have done. Or there's at least a much longer lag until they start feeling it. The tea goes cold very slowly. If the tea went cold more quickly, maybe people will think again about the choices that they are doing.

What can the Bank of England, when it raises interest rates, which seems to be the primary tool it has available, that makes the cost of borrowing more expensive. Does that restore the faith in international lenders that the British government is a good bet to lend money to? Of course, that mechanism does exist. If you raise interest rates, you cool off inflation expectations, right? Because you're trying to show to the markets that you are serious about inflation, even if that means you are willing to cause a recession. Raising interest rates is likely to cause recessions, although it's constant, but it's also certain to decrease

inflation expectations and with a lag to decrease inflation rates. But of course, the trade-off is, again, you're likely to cause a recession. For example, Paul Volcker in the United States in the 80s was known to be somebody who was willing to cause a recession to show people he was serious about bringing inflation down. And he did. Although the earlier inflation that had a different set of causes than what we are seeing today. Like you said, open market operations such as investing or divesting in government securities in order to manipulate interest rates is one of the tools central banks have. In later years, actually, since the times of quantitative easing and the sovereign debt crisis,

they've been using a wider set of tools, in fact, in addition to just the classic open market operations. But that's one tool that it's still a central tool of what they do. What effect did the Bank of England becoming nationalized after the Second World War and then given more autonomy by the Labour government at the end of the 20th century. What effect does that have historically on the operation of the bank? Well, in many European countries, this happened. It was not just a British thing, as most things are not by the 20th century. By the 20th century, your country is not so special, unlike what it may think of itself. And by that time, this happened in many countries. And the reason was was it was

consensual by then that central banks had a systemic role and they were very central for the economy. And it did not make sense for them to potentially act only in the interest of their shareholders' profits. But de facto, this was a situation going far back, far back. But it became more and more obvious as time went by. Precisely as a result of this, though, you had the opposite risk. You had the risk that governments instrumentalized, especially in a democracy where governments have very short-term outcomes. Sometimes they have very me-optic objectives

because government in power in one moment just wants to win the next election. So there was the risk that governments instrumentalized the central banks if they were under their control, if they did not have a monetary policy autonomy, just for short-term political objectives. And that is what the movement for independence of central banks is going to come from, you know, to give them autonomy to do what is best for the economy, you know, and have still very indirect democratic control over it. But, you know, release it from the short term pressures of whoever is in government in one moment. Because, you know, I'm not like this free market person that some economists have the reputation of being.

I'm in favor of markets together with governments working together for a common goal. But I also don't have a romantic view of politicians that are there to do the common good. You know, there are people just like the rest of us, and they are there first and foremost for their own interests. And so we should look at politics without romance. And so one way to do that is to design institutions that get a bit of the best of both worlds and trying to give central bank independence, I think was a good idea because then we can discuss on an intellectual level, what is the objectives of a central bank, regardless of any short-term pressures from

the government in power wanting to win the next election. Now, whether that means that central banks today have the right objective function or not for society, that's a different question. And I think actually they now have to rethink a bit what is their objective function. Lots to think about, I suspect, for the Bank of England this week and indeed anyone involved with writing the British economy. The exciting week lies ahead.

And that's before we've even factored in what Vladimir Putin's going to drop. Thank you very much, Nuno. Thank you for coming on. How can people find out more about your work? I'm actually writing a book on monetary history that is going to be for a general audience, in addition to more academic work.

So, you know, if they Google, they should find my name. Well, thank you very much indeed. Thank you then. you