Banking and Currency Schools

The debates between the Banking School and the Currency School are of central impor- tance in considering the role of money and banks in a capitalist system. They can be connected with the bullion controversy of the early nineteenth century, whose main protagonists were Henry Thornton and David Ricardo, and are also linked to the finan- cial revolution parallel with, and a necessary complement to, the industrial revolution in Great Britain (Cameron, 1967).

The debates focused on two central themes: (i) the criteria to adopt with respect to money emission; and (ii) the extent of the Bank of England’s power. The crises charac- terizing the first half of the nineteenth century (1825–26, 1836, 1839) largely conditioned attitudes, leading to much criticism against the Bank of England.

The Currency School was anchored in Ricardo’s theory that the quantity of money in circulation should be limited according to precise rules. Torrens (1837) and Overstone (1857) also assumed this position, adopting the quantity theory of money and the price– specie flow mechanism and underwriting a definition of money that included, besides metal-based money, banknotes issued by the Bank of England and by other banks. The task of the Bank of England was thus to control the quantity of money in circulation in order to ensure that prices remained stable.

The Peel Act of July 1844 represented a significant moment in the debate on monetary issue, endorsing the positions of the Currency School. The Bank of England, which was granted a monopoly in monetary issue, was divided into two departments, according to a model similar to that adopted by the Swedish Riksbank: monetary issue was assigned to the Issue Department, while the Banking Department carried out the functions tradi- tionally allotted to commercial banks.

Proponents of the Banking School were highly critical of this reorganization, and its supporters (Tooke, Gilbart, Wilson and Fullarton) rejected the quantity-theory- of-money approach of the Currency School. In their History of Prices, Tooke and Newmarch (1838–57) pointed out that variation in prices was not caused by variation in the quantity of money in circulation but rather by elements affecting production costs or goods supply. The authors underlined the endogenous nature of money supply and sug- gested, as an alternative, a wider definition of money, to include also the units issued by banks and by private individuals. Further, according to Tooke and Newmarch (1838–57), Tooke (1844) and Fullarton (1845), the “law of reflux” insured against the risk of over- emission, avoiding the danger of inflation.

In reply to the observation of the Banking School that banknotes were always issued by the central bank in order to satisfy commercial needs (in which case an effective over- issue of paper money had no reason to occur), the supporters of the Currency School denied the analytical relevance of the term “commercial needs”, because in their opinion these needs were subject to change with every variation in the rate of interest.

The debate between the Currency School and the Banking School represented a prelude to more recent discussions on the monetary nature of a capitalist economy. While the former School anticipated the monetarist theories in some ways, the more or less recent developments of the Keynesian tradition appear closer to the latter.

Following the Currency School, Friedman (1968, 1987) considered money supply an exogenous dimension, controlled by the central bank to avoid inflation. Post-Keynesian thinking (since the Radcliffe Report (1959) and the contributions of Kaldor (1970, 1982) and Kaldor and Trevithick (1981)) have, rather, underlined the endogenous nature of money supply: money is credit driven and demand determined. As for the Banking School, the law of reflux prevents over-issue of money.

Unlike those who (see Kindleberger, 1978) underline its relevance today, Blaug (1968) attributed little importance of that controversy to present questions on the grounds that neither of the Schools was able to recognize the essential functions of a central bank. This conclusion does not appear convincing, however.

Contrary to Blaug’s (1968) argument, the contributions of the Banking School and the Currency School still have considerable relevance today, especially in light of the global economic and financial crisis that erupted in 2008. The theoretical considerations con- cerning the monetary field formulated over the last few decades have emphasized that it is no longer possible to disregard the endogenous nature of money supply, and that it is necessary to define the role and the responsibilities of the banking system (see Figuera, 2001).

See also:

Bank Act of 1844; Bank of England; Bullionist debates; Endogenous money; Inflation; Monetarism; Money creation; Money supply; Quantity theory of money; Reflux mecha- nism; Ricardo, David; Thornton, Henry.