The obverse of cheap money, ‘dear money’ is also used to denote episodes in which central banks have raised (short-term) interest rates deliberately to bring about a contraction of money or credit, often in order to preserve a fixed exchange rate. The historical episodes are memorable for their effects on economic activity and on subsequent monetary theory and policy.

The major financial crises of the 19th century were accompanied by the Bank of England’s raising of its discount rate (Bank rate) to at least 5% (the maximum permitted under the usury laws until 1833) in order to protect the gold reserve from an internal or external drain. The tradition as it developed after the Bank Charter Act of 1844 was for the Bank to act as a lender of last resort even when that involved an expansion of the fixed fiduciary note issue imposed by the Act, but at a penal rate. Hence Bank rate went to 8% in 1847, 10% in 1857 and again in 1866, 9% in 1873, but only 6% in the Baring crisis of 1890, the smooth handling of which was seen as a success for the Bank’s methods (Hawtrey 1938, chs 1 and 3; Morgan 1943, chs 7–9; Clapham 1944, Vol. 2, ch. 6; Sayers 1976, pp. 1–3). In the early 20th century the events of the crisis of 1907 seemed to confirm the utility of central banks in general and the efficacy of Bank rate in particular. When the American stock exchange boom broke, Bank rate was quickly raised to 7% in response to gold outflows from London. The outflows were swiftly reversed while a banking panic in the US turned into a severe though short-lived slump. The outcome in the US was the establishment of the National Monetary Commission in 1908 and the Federal Reserve System which it recommended, in 1914. In Britain, belief in the power of interest rates to influence economic activity was reinforced, and lasted for a generation (Hawtrey 1938, pp. 115–18; Friedman and Schwartz 1963, pp. 156–74; Sayers 1957, pp. 62–4; Sayers 1976, pp. 54–60; Keynes 1930, Vol. I, ch. 13).

After World War I dear money was applied again, vigorously but after some hesitation, in both Britain and America to curb the postwar boom: Bank rate went to 6% in November 1919, 7% in April 1920, the Federal Reserve Bank of New York rediscount rate to 6% in January 1920. In both countries the rises came too late and were too strong: the restocking boom was already breaking and the subsequent slump was severe and (in the UK) prolonged (Friedman and Schwartz 1963, pp. 221–39; Howson 1974, 1975, ch. 2). The Federal System continued to experiment in the 1920s with the use of interest rates to control the domestic economy (Chandler 1958; Friedman and Schwartz 1963, ch. 6), but elsewhere, with many countries struggling to return to or maintain the international gold standard, dear money, in the sense of high (short-term) interest rates was frequently and widely used for balance of payments reasons (Clarke 1967; Moggridge 1972). It was with considerable relief that countries falling off the gold standard in the 1930s took advantage of their new-found monetary independence to promote cheap money. The revival of monetary policy on both sides of the Atlantic after 1951 did not involve the use of dear money in traditional ways: concern with price stability was initially tempered by the objective of ‘full employment’ and in Britain at least interest rate rises for the sake of external balance were usually employed only as one element in ‘packages’ of deflationary measures; by the time the reduction of inflation became an important objective dear money as a target or as an indicator of monetary policy had been replaced by the rate of growth of the money supply (Dow 1964, ch. 3; OECD 1974; Blackaby 1978, chs 5 and 6).

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