Money, Banks and Finance in Economic Thought

A Review of the History of the Bank of England: Did money every cause UK inflation?

Milne Alistair, Loughborough University
Wood Justine, Loughborough University

The recent substantial increase in base or outside money created by the programmes of quantitative easing of the Federal Reserve, the Bank of England, the Bank of Japan and the European Central Bank has not resulted in the rise of nominal spending and prices predicted by the simple ‘money multiplier’ version of the quantity theory. This observation leads us to use the Bank of England historical database to examine the following two issues: when, and under what circumstances, have increases in the outside money in the UK resulted in rising nominal spending and prices? how has the historical response of nominal spending and the price level to changes in base money depended on the institutional environment, economic thought at the time, and the framework for monetary policy? Tracing the quantity theory of money from Hume to Friedman and utilizing VAR estimations, we evaluate the closeness of the relationship between outside money and inflation in the UK, with reference to institutional environment, development of the banking system, and the framework of monetary policy, including the gold standard and inflation targeting. Our findings show that the relationship between base money and inflation in the UK has varied greatly over the past three centuries. We conclude by discussing what our historical empirical investigation can tell us about contemporary proposals for stimulus measures based on direct finance of either government spending or fiscal redistribution through creation of base money.


Keywords: central banking; inflation; monetary policy transmission mechanism; quantity theory of money; history of banking