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Portrait of Central banks and interest rates

General knowledge · Economics & society

Central banks and interest rates

Sveriges Riksbank 1668; Bank of England 1694; UK operational independence 1997

Economics — monetary policy and the price of money

A central bank is the institution that issues a country's currency, acts as banker to the government and lender of last resort to the banking system, and — in the modern arrangement — sets a short-term interest rate in pursuit of a target for inflation. The Swedish Riksbank of 1668 is the oldest, the Bank of England of 1694 the most imitated. Since the 1990s the dominant model has been an independent central bank with an explicit inflation target, a design intended to stop governments cutting rates before elections; the 2008 crisis and the pandemic added balance-sheet tools such as quantitative easing, and the argument over how far an unelected body should go is very much alive.

How to spot them

  • ▸The Old Lady of Threadneedle Street, from a Gillray cartoon of 1797
  • ▸A nine-member committee meeting eight times a year, the Governor's vote counting as one
  • ▸Bagehot's rule: lend freely, at a high rate of interest, on good security
  • ▸Twelve regional banks and an Open Market Committee; or a tower in Frankfurt with a single mandate

Key facts

Founded in 1668, and the oldest institution of its kind still operating (1668)

Sveriges Riksbank, which also endowed the economics prize in 1968 on its 300th anniversary

Founded in 1694 to raise a loan for a war against France, nationalised in 1946 (1694)

The Bank of England; its founding subscription funded William III's war

James Gillray's 1797 cartoon of an elderly woman in a dress of banknotes, sitting on a chest (1797)

The origin of the nickname 'the Old Lady of Threadneedle Street'

Gordon Brown handed over control of the interest rate five days after the 1997 general election (1997)

6 May 1997; the Monetary Policy Committee first met in June and independence was put on a statutory footing by the Bank of England Act 1998

Walter Bagehot's 1873 rule for a crisis: lend freely, at a penalty rate, on good collateral (1873)

From Lombard Street; still the textbook statement of the lender-of-last-resort function

Created by an Act of Congress in 1913 with twelve regional banks and a dual mandate (1913)

The Federal Reserve System, charged with both maximum employment and stable prices

Buying government bonds with newly created reserves to push down long-term yields (2009)

Quantitative easing, adopted by the Bank of England in March 2009 and on a vast scale after 2020

Key ideas

  • Independence is meant to solve a time-consistency problem: a government that can set rates has an incentive to promise low inflation and then deliver a boom, so promises are not believed. Handing the lever to an insulated committee makes the promise credible.
  • Operational independence is not goal independence: in Britain the Chancellor sets the target and the Bank decides how to hit it.
  • The Taylor rule, set out by John Taylor in 1993, is a simple formula prescribing the policy rate from inflation and the output gap; it is a benchmark rather than a rule any bank actually follows.
  • When rates reach the effective lower bound, conventional policy runs out and banks turn to asset purchases, forward guidance or, in a few cases, negative rates.

Quick-fire facts

  • •Sveriges Riksbank, founded in 1668, is the world's oldest central bank; the Bank of England followed in 1694
  • •The Bank of England was nationalised in 1946 and given operational independence over interest rates by Gordon Brown on 6 May 1997
  • •Its Monetary Policy Committee has nine members and normally meets eight times a year; the Governor has one vote and a casting vote in a tie
  • •Andrew Bailey has been Governor of the Bank of England since March 2020, with a term running to 2028
  • •The US Federal Reserve was created by the Federal Reserve Act of 1913 and has twelve regional Reserve Banks; rates are set by the Federal Open Market Committee
  • •Kevin Warsh was sworn in as chair of the Federal Reserve in May 2026, succeeding Jerome Powell, who had chaired the Fed since 2018 and remained on the Board
  • •The European Central Bank began operating in 1998, is based in Frankfurt, and has been headed by Christine Lagarde since November 2019; its target was restated in 2021 as a symmetric 2 per cent
  • •The Fed is unusual in having a dual mandate — maximum employment as well as stable prices; the ECB's primary mandate is price stability alone
  • •The phrase 'lender of last resort' is associated with Walter Bagehot's Lombard Street (1873), though the idea is older, going back to Henry Thornton
  • •The Bank of Japan introduced negative interest rates in 2016 and ended them in March 2024, its first rise in seventeen years
  • •The Bank for International Settlements in Basel, founded in 1930, is often called the central bankers' bank

Drill it — 9 cards

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Sources