Keynes on Central Banking and the Structure of Monetary Policy

John Maynard Keynes's monetary works, from A Tract on Monetary Reform to A Treatise on Money and The General Theory, are well known for their insights into the functioning of monetary economies and the conduct of monetary policy in such economies, that is, the appropriate goals of, and ways to implement, monetary policy. Less well known is that Keynes also thought carefully about the appropriate structure of monetary policy: the regulation of central banks and their relation to the state in matters of monetary policy.

In fact, in recent years discussions in monetary economics have often concentrated on the structure rather than the conduct of monetary policy. The notion of “central bank independence” in particular has received enormous popular attention as well as scientific support from a literature dealing with the so-called time-inconsistency problem allegedly afflicting “discretionary” arrangements in monetary policy.¹ While the notion of central bank independence is clearly meant to capture some elements of the relation between the central bank and the state implicitly held to be essential in solving the alleged time-inconsistency problem, it is often not made clear what the crucial responsibilities of an independent central bank exactly should be, and how and to whom it should be held to account on its performance. Yet it would seem to be of little use to claim anything for “independence” as such, and it may even be positively misleading to sell independence as a free lunch when what really matters is the precise form and degree of independence.

It is thus of some interest that Keynes in 1932 provided an outline of a particular form and degree of independence that he thought would promote efficiency in the conduct of monetary policy and allow ultimate democratic control over policy to be retained at the same time. The analysis of Keynes's proposal of 1932 for a sound structure of monetary policy will be our main objective here.

However, as Keynes's proposal of 1932 itself is little more than a sketch of certain essential aspects, some of which may even sound ambiguous to the modern reader, I felt that some background might be helpful. We could then judge the proposal within the wider context of Keynes's monetary thought, particularly his evolving views on central banking and the structure of monetary policy. Section 1 therefore begins with a plan that Keynes had devised in 1913 for a central bank in India. Here the issue was whether a central bank should be established in the first place and, if so, what its functions and its relation to the state should be. Keynes's plan strictly refers to the classical gold-standard era and the Indian rupee's gold-exchange standard, conditions soon to be swept away.

Section 2 covers the monetary upheavals of World War I and its aftermath, leading first to Britain's return to gold in April 1925 and then to sterling's subsequent and final departure from gold in September 1931. While Keynes's views on the proper conduct of monetary policy were by then already strongly opposed to the nostalgic drive at monetary reconstruction that characterized the 1920s, we discuss further evidence on his views as to a sound structure of policy from this interim period, ending with the September 1931 sterling crisis. After discussing Keynes's proposal of 1932 in section 3, the discussion in section 4 briefly follows up on the early post–General Theory era, which saw Keynes as a director of the Bank of England between 1941 and 1946 and the bank's nationalization on 1 March 1946. Section 5 concludes.

Overall, the analysis shows that Keynes's 1932 proposal is an original contribution to the issue of central bank independence that is relevant to modern discussions. Not least, his proposal is of interest for its resemblance to the United Kingdom's new monetary arrangements introduced in...