Monetary Theory, the Banking System, and the Responsibilities of a Central Bank. Ricardo's Approach revisited.
The global economic crisis has reopened the debate on the functions of central banks. As the consensus view abandons the "inflation-targeting" approach and its one-objective, one-instrument policy structure, economists once again become aware of the wider spectrum of central banks’ responsibilities for economic well-being. In this context, helpful insights on current perspectives may be gained by tracing back this debate to its origins at a time when central banks were in the making, and the intellectual discovery of their role stimulated controversies between economists, central bankers and policy-makers. I explore these origins in the works of David Ricardo and Walter Bagehot. Ricardo’s criticism of the Bank of England is considered here within the framework of his approach to the gold standard as an anchor for the price level, and his views concerning the loss of this anchor in the Restriction period (1797-1821). Because the Bank privileged its profit objectives over its public responsibilities, he argued, under the new circumstances no adjustment mechanism substituted for the gold standard's stabilizing properties. This is why deep reforms in the ownership and the operational structure of the Bank were necessary. The paper argues that, in his positive approach to money, Ricardo did not regard money as neutral, but in the normative part of his theory, he tried to devise a monetary system where it would be made neutral so that the real variables (prices and distribution) would not be affected by monetary effects. In the Nineteenth century, British economists laid the foundations of much of the modern theory of central banking. This paper develops the "Minimalism vs. Activism" classification previously proposed by the author as an analytical prism through which to view some key aspects of central banking theory and practice, and tries to answer the question how Ricardo fits into it.
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Keywords: monetary theory; central banks; price stability; financial stability; Ricardo; Bagehot
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