A Brief History Of The Bank Of England’s Endogenous Money Policies: An Ode To Roy Harrod

by Philip Pilkington

Roy Harrod, usually remembered today for his part in the development of the Harrod-Domar growth model was also, so far as I can see, the most sophisticated monetary economist among the early Post-Keynesians. His book Money, designed as a sort of textbook put together over the years using his lecture notes, is a testament to how a course on monetary economics should be taught.

Harrod should probably be credited, for example, with the first truly institutional description of endogenous money theory — a theory that the Bank of England has now come to endorse. In his book he discusses how the British banks of the time lend to one another in the open market — this was done by scrambling for ‘call money’ when they found that their books didn’t balance. Call money is so called because you literally pick up the phone and call a variety of lenders to try and raise the money needed to meet the reserve requirements in place at any given moment in time.

Harrod was well aware that “loans create deposits” — indeed he uses the phrase quite a few times in the book — and that banks then seek to raise the money to meet the reserve requirements after, not before, the loans are made. If they cannot fill the gap in the market for call money they turn to the Bank of England. Here I will quote from Harrod at length to show just how ahead of his time he was.

If, as a result of these operations, including of a calling in of call money, they [i.e. the banks] find themselves unable to balance their books, they can resort to the Bank of England, and rediscount bills with it. Here the Bank of England operates in its role as lender of last resort. In normal conditions the discount market has to borrow from the Bank of England at Bank Rate [i.e. the British equivalent to the Fed Funds rate]. This is above the market rate on bills, and thus during the period of such borrowing the Discount Houses [i.e. effectively, the banks] find themselves making a loss. They will have lent money on bills at one rate and have had to borrow from the Bank of England at a higher rate, commonly called the penal rate. It is accordingly highly expedient for them to get out of debt to the Bank of England as quickly as possible. They must therefore firm up their own rates, so as to discourage borrowers and encourage lenders. The Bank Rate thus has a powerful effect on open market interest rates. (pp51-52)

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