EC204 Events

Early modern finance 1000-1600

Europe moves away from family-based lending to impersonal exchange. Italian city states invent bills of exchange, Dutch towns issue annuities, and Amsterdam becomes the first equity market. Europe has a foundation for modern finance like public debt, equity markets and impersonal exchange

The Glorious Revolution (1688)

England has irresponsible monarchs so Parliament steps in and gains fiscal oversight. Parliament controls taxation and borrowing. Royal debt becomes national debt, separation of monarchy and state finance. This created credible institutions which the government cannot easily default debt. England becomes the most credible borrower in Europe, allowing for wartime financing.

Founding the Bank of England (1694)

England needs a stable institution to manage war finance against France, so a group of private investors create the Bank of England. It’s privately chartered, not a government bank but manages government debt. Due to it’s independence, it is safe from government/political influence, preventing default. This bank becomes the anchor of Britain’s financial system.

The Gold Standard (1717)

Britain has a messy bimetallic system of silver and gold. Isaac Newton, sets the mint ratio too high for silver and silver becomes so undervalued that it disappears from circulation. Gold becomes the dominant currency and Britain enters the gold standard. Britain has monetary credibility due to its gold convertibility.

Gold Standard as a Contingent Commitment (1717-1914)

Britain needs to finance expensive wars while maintaining monetary stability. Britain decides to stay on gold in normal times but suspend during wartime. During wartime, Britain borrows heavily → leads to tax smoothing (avoid wartime taxes and pay later) → after the war, Britain returns to gold proving its credibility. Multiple returns to the gold standard like this solves the time-inconsistency problem. France did not solve the time inconsistency problem, they kept messing with the currency and defaulted.

The July Crisis (1914)

Europe has many alliances so when Archduke Franz Ferdinand is assassinated, Austria calls on its allies and so do the other countries like a domino effect. WW1 begins and gold convertibility is suspended.

WW1 (1914-1918)

Britain enters the war and gold convertibility is suspended and relies on debt. Britain issues a lot of internal and external debt. Inflation rises because governments print money. exchange rates become unstable and roll-over risk increases as short term debt piles up. By 1918, the Gold Standard collapses.

Post-WW1 (1928-1929)

After WW1, global finance is unstable and the US becomes the world’s financial center. The Federal Reserve raises interest rates to curb stock speculation. Theories as to why the Fed tightening failed: Leaning against the wind, Rational Bubble, Fundamentals vs Bubble.