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History of Political Economy 35.1 (2003) 1-19

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The Lender-of-Last-Resort Concept in Britain

Denis O'Brien

The idea that a fractional reserve banking system needs a lender of last resort is so deeply embedded in the mentality of most economists (with the possible exception of members of the free banking school) that it seems to many to be unquestionable.1 Yet this was not always so. Even in the two most highly developed economies in the nineteenth century, those of Britain and the United States, the idea underwent a long struggle for recognition. It developed slowly, in the teeth of considerable resistance, with the debate being shaped to a considerable extent by the pressure of events.

This essay traces the development of the idea in Britain, where it is [End Page 1] widely recognized to have originated in the 1790s, and to have been articulated by Francis Baring and Henry Thornton (section 1). The Bank of England was reluctant to accept such a role; but the financial crisis of 1825 witnessed a dramatic volte-face on the part of the Bank, which, literally overnight, changed its policy, from one of resistance to requests for assistance to that of lending freely (section 2). A key question, largely ignored in the literature, is the origin of that remarkable change (section 3).

Following the events of 1825, the role of the Bank as lender of last resort was examined during the course of the select committee hearings of 1832 on the renewal of the Bank charter (section 4). In the subsequent debate during the 1830s, Thomas Joplin played a significant role (section 5). During the debate the currency school strongly, and for theoretically cogent reasons,2 opposed the idea that the Bank should have a last-resort role, and was successful in seeing the logic of its opposition embodied in the 1844 Bank Charter Act (section 6). But the credibility of the act was damaged by a crisis only three years later, a crisis, moreover, in which the question of the availability of last-resort facilities played a central role (section 7). An even more severe crisis of a similar type was to follow in 1857 (section 8). The experience of the act in operation had pinpointed a central flaw in the application of the currency school model in the context of an economy such as Britain's, in which there was only one centrally held reserve for the whole financial system. In these circumstances the Bank, the holder of that reserve, was forced, despite strong resistance from some of its own directors, to accept its position as lender of last resort (section 9).

Walter Bagehot's Lombard Street (1873), widely associated in later literature with the formulation of the last-resort doctrine, in truth rationalized and analyzed (albeit with outstanding ability) the outcome of an eighty-year process of development of an initial idea. It is the history of that process which is explored in this article.

1. The 1790s: Baring and Thornton

The lender-of-last-resort concept developed in Britain over a period extending from the 1790s to the 1870s. While it is true that the Bank of [End Page 2] England extended assistance to banks in the eighteenth century (Baring [1797] 1967, 14), it was really only in the 1790s, as war with France threatened financial stability, that the concept of the Bank as indeed the “last resort” crystallized. As so often with the genuinely important ideas in economics, it was the pressure of events that brought about the recognition.

Credit for the initial formulation of the idea goes to two writers, Sir Francis Baring and Henry Thornton. It was Baring who published first; he identified a failure of the Bank to recognize its unique position as having precipitated the financial crisis of 1793, in which the liquidity of the system was saved only by direct government intervention and the issue of exchequer bills (Baring [1797] 1967, 22; [Horner] [1802] 1994, 135). The Bank, he argued, had rationed discounts so severely that it had...


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