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

Clearly the Bank of England sets the Bank Rate and allows the quantity of money to float. The Bank Rate and the lending rate gravitate toward each other because when banks extend sufficient loans that they are forced to borrow at the penal rate from the central bank they will quickly be incentivised to raise their own rates to squeeze off lending. Harrod is quite clear that this is how the process of money creation works. He continues,

When the market borrows from the Bank, this has the effect of increasing the money supply (deposits and notes) in the country, so long as this borrowing is outstanding. (p52)**

Harrod goes on to note that this system is different to the one in the US at the time (i.e. the post-war era). In the US the Federal Reserve was far less concerned with penalising banks. Although the mechanics of the monetary system were very similar, the institutional structure of the British system (in the post-war era) was far more geared toward penalising banks that borrowed from the central bank.

This was because of the peculiar situation in Britain at this time. In the post-war years, the British were very self-conscious about their balance of payments. Any time the balance of payments began to deteriorate the British authorities would try to bring the economy to a halt. This became known as the economic policy of ‘stop-start’ and it greatly hampered the ability of Keynesian policymakers to keep economic growth high at the time. Thus, the institutional structure of the Bank of England came to reflect the need for a central bank that could quickly ‘squeeze’ the market for funds when the balance of payments started to deteriorate.

The US, on the other hand, were rather cavalier about their balance of payments position in this era. After all, the Bretton Woods system at the time was based on the dollar and they issued the dollar. Indeed, many countries were more than happy when the US ran balance of payments deficits as this meant an outflow of dollars which developing countries could use to expand economic activity.

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