The limits to “whatever it takes”: Lessons from the gold standard

Stefano Ugolini

30 August 2016



Economists generally agree that Mario Draghi’s London speech on 26 July 2012 was crucial in stopping the self-fulfilling Eurozone crisis (Rebooting Consensus Authors 2015). While markets were awed by the ECB President’s pledge to do “whatever it takes” to preserve the euro, only a few observers paid attention to the limitations attached to this vow—“within our mandate”.

As always, the devil is in the details. In 2012, markets apparently chose not to test the limits of the ECB’s new commitment. No doubt, it would have been difficult to contend that the Eurosystem did not possess enough firepower to make its pledge credible. However, even in case the economic sustainability of a given monetary policy is unquestionable, its political sustainability is not necessarily so. Central bankers’ actions are embedded into a specific institutional context, and such a context is crucial in determining to what extent the pursuit of monetary targets is going to be effective.

The institutional constraints to central bankers’ actions

  • Textbooks assume that the right to issue cash allows the central bank to expand liabilities at will, thus subtracting it from the basic constraints to which all other banks are subjected. The strength of such an organisation (i.e. the sustainability of its monetary policy) is theoretically infinite.
  • But real-world central banks are not merely money-issuing agencies – they are complex organisations endowed with a bundle of different (and possibly conflicting) tasks (Ugolini 2011). As a result, their strength depends on the combination of their rights and obligations. The strength of real-world central banks (i.e. the sustainability of their policies) is then decidedly finite, and its extent is a fundamental determinant of their ability to pursue their targets effectively (Stella 1997, Bindseil et al. 2004, Archer and Moser-Boehm 2013).
  • The existence of a correlation between central bank strength and policy effectiveness is confirmed by a number of empirical studies (e.g. Klüh and Stella 2008, Adler et al. 2012, Perera et al. 2013). All enquiries, however, only cover recent periods, and one might wonder whether their conclusions are tied to the peculiarities of today’s international monetary system – especially in the case of peripheral countries, whose short-dated adoption of ‘sound’ monetary targets might be at the root of poor policy effectiveness.
  • As a result, it is interesting to ask whether also core countries with a consolidated record of policy target stability may be vulnerable to the same kind of problem.

An illustrative case: The Bank of England in the heyday of the gold standard

In a recent paper, I argue that the Bank of England (BoE) during the final era of the classical gold standard (1889-1914) provides a relevant case to test whether the correlation between central bank strength and policy effectiveness also applies to core central banks with a long-standing commitment to ‘sound’ monetary policy (Ugolini 2016).

  • The BoE stood at the very centre of the global monetary system – the pound sterling was by far the leading international currency of the time, and the ‘Old Lady of Threadneedle Street’ was seen as “the conductor of the international orchestra” (Keynes 1930).
  • The BoE’s staunch attachment to conservative monetary policy was universally acknowledged – in spite of the occurrence of a series of violent financial crises, the pound’s convertibility into gold had never been discontinued since 1821, and official gold reserves had never fallen below legal limits since 1866.

Despite this remarkably successful record, however, the BoE suffered from a fundamental weakness due to the mutual inconsistency of the package of rights and obligations assigned to it:

  • On the one hand, the BoE was expected not only to preserve gold convertibility, but also to perform balance sheet policy aggressively in case of crisis (viz. unlimited lending of last resort through its non-stigmatised standing facilities).
  • On the other hand, the Bank lacked adequate financial resources for performing balance sheet policy on a satisfactory scale without jeopardising convertibility. Political factors prevented the BoE from securing additional ways to expand its liabilities – shareholders opposed additional capital calls; Parliament opposed an increase of banknote circulation; and bankers’ lobbies opposed the introduction of reserve requirements.

The sustainability of the BoE’s monetary policy

To what extent was the BoE’s monetary policy sustainable? Or differently put – given the constraints that were imposed on it, how much of the money market would the BoE have been able to ‘internalise’ in its balance sheets while performing its lending-of-last-resort functions?

  • At the time Walter Bagehot wrote Lombard Street, the central bank was still relatively big with respect to the money market, and this made internalisation of a sizeable portion of it a viable option (Bagehot 1873, V.3).
  • By the end of the century, however, this was no longer the case. The growth of the BoE’s balance sheets had not kept pace with that of the overall financial sector – the ratio of the central bank’s assets to the total assets of UK financial institutions was low and slightly shrinking (Table 1).

Table 1. Size of selected central bank assets and liabilities relative to GDP for a number of countries, 1909

Source: Ugolini (2016). Note: As (due to commercial banks’ window-dressing practices) the BoE’s balance sheet were on average much larger at year’s end than in the rest of the year, data for mid-December are also provided.

  • This is confirmed by the fact that the BoE was small by the international standards of time (Figure 1). It was also small by nowadays’ standards – its balance sheet’s size was around 5% of GDP in 1909, comparing with 17% for the ECB and 24% for the Fed in 2014 (Constâncio 2015).

Figure 1. Ratio of central bank assets to total assets of the banking system (UK, 1891-1909)

Source: Ugolini (2016).

This means that a huge (and growing) amount of assets had the potential to find its way to the BoE’s balance sheet, but only a small (and shrinking) share of this stock could actually be accommodated. This was due to the fact that the expansion of the BoE’s portfolio during crises was not matched by an enduring expansion of its liabilities. Why? Because the banking system was unwilling to keep deposits with the central bank, and used to withdraw as soon as possible all the liquidity it was provided through the standing facilities. As bankers’ lobbies had fiercely resisted the introduction of both reserve requirements and reserve remuneration, the BoE could not force or incentivise banks to keep resources deposited with it.

This situation made monetary policy implementation increasingly difficult over time:

  • Due to the strict constraints imposed on its balance sheet adjustment process, the BoE got increasingly obliged to move official interest rates aggressively in order to discourage use of its standing facilities.
  • As a result, domestic interest rates got much more volatile in the UK than elsewhere (Figure 2). Such violent fluctuations were unanimously considered as obnoxious to the real economy. Industrialists, politicians, and authoritative economists started to complain loudly about the situation (see e.g. Palgrave 1903).

Figure 2. Central bank and market interest rate average level (horizontal axis) and volatility (vertical axis) in a number of European countries (weekly data)

Source: Ugolini (2016).

The contradictions of the system eventually exploded in July 1914, when (in spite of huge capital inflows towards the UK) the Bank proved unable to sustain the whole demand for cash at its standing facilities, and actually defaulted on its convertibility mandate well before the beginning of WWI (Keynes 1914, De Cecco 1974, Roberts 2013).


No doubt, the BoE under the gold standard was very different from nowadays’ central banks. However, this example is relevant in pointing out that institutional constraints matter (a lot) for any central bank, even the most systemic and reputed one. The fact that inconsistent central bank mandates can potentially jeopardise the conduct of monetary policy was recently confirmed by the dramatic U-turn performed by the Swiss National Bank in January 2015:

  • In obedience to its monetary stability mandate, the Swiss National Bank had long been explicitly committed to cap the appreciation of the franc with respect to the euro.
  • The risk of facing losses on its huge foreign reserves, however, put enormous political pressure on the BoE from its main shareholders (the cantons).
  • In the end, exchange rate commitments proved too difficult to justify in the long term and had to be brutally defaulted (Brunnermeier and James 2015).

As in the case of the 19th century BoE, the recent Swiss example shows that an economically sustainable monetary policy can well be politically unsustainable – thus leading to its eventual demise. There might be lessons looming here for the Eurozone too – before markets might be tempted to test the political sustainability of the ECB’s policy, it might well be worth clarifying the institutional constraints to the Eurosystem’s action – whose contours currently appear to remain dangerously blurred.


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Archer, D and P Moser-Boehm (2013) “Central bank finances”, BIS Paper 71.

Bagehot, W (1873) Lombard Street: A Description of the Money Market, London: King.

Bindseil, U, A Manzanares and B Weller (2004) “The role of central bank capital revisited”, ECB Working Paper 392.

Brunnermeier, M and H James (2015) “Making sense of the Swiss shock”, Project Syndicate, 17 January.

Constâncio, V (2015) “Central banks with large balance sheets”, US Monetary Forum, 27 February.

De Cecco, M (1974) Money and Empire: The International Gold Standard, Oxford: Blackwell.

Keynes, J M (1914) “War and the financial system, August 1914”, Economic Journal, 24(95): 460-86.

Keynes, J M (1930) A Treatise on Money: The Applied Theory of Money, vol 2, London: Macmillan.

Klüh, U and P Stella (2008) “Central bank financial strength and policy performance: An econometric evaluation”, IMF Working Paper 08/176.

Palgrave, R. H. Inglis (1903), The Bank Rate and the Money Market in England, France, Germany, Holland, and Belgium 1844-1900, London: Murray.

Perera, A, D Ralston and J Wickramanayake (2013) “Central bank financial strength and inflation: Is there a robust link?”, Journal of Financial Stability, 9: 399-414.

Rebooting Consensus Authors (2015) “Rebooting the Eurozone: Step 1 – Agreeing a Crisis Narrative”, VoxEU, 20 November.

Roberts, R (2013), Saving the City: The Great Financial Crisis of 1914, Oxford: Oxford University Press.

Stella, P (1997) “Do central banks need capital?”, IMF Working Paper 97/83.

Ugolini, S (2011) "What future for central banking? Insights from the past”, VoxEU, 11 December.

Ugolini, S (2016) “Liquidity management and central bank strength: Bank of England operations reloaded, 1889-1910”, Norges Bank Working Paper 10/2016.



Topics:  Economic history Financial regulation and banking Macroeconomic policy

Tags:  central banking, Bank of England, gold standard, ECB, eurozone

Assistant Professor of Economics, University of Toulouse