Lombard Street - Walter Bagehot

Discussion Questions
FTE/PTA Conference
Perspectives From and On the Federal Reserve System
Next week I will be traveling to Washington DC for a conference sponsored by the Foundation for Teaching Economics - Perspectives From and On the Federal Reserve System Conference. This PTA Members-Only conference, co-hosted by The Federal Reserve Board of Governors and The Federal Reserve Bank of Richmond, will be held April 26^th – 28^th.
In reading Walter Bagehot's classic I have come up with a number of ideas/comments/questions that I am looking forward to discussing with my colleagues.

Lombard Street – Bagehot

1. Macroeconomists compare and contrast monetary policy by rule v monetary policy by discretion. How does Bagehot address this question and which approach does he seem to favor?

2. Benjamin Bernanke outlines 3 roles for a central bank: macroeconomic stability, intervention during panics and bank supervision/regulation. Bagehot offers the maxim that the central bank (Bank of England) should lend freely on good credit at high rates. How does Bagehot develop this argument and how might his maxim impact the three functions described by Bernanke?

3. Monetary policy makes use of reserves as a key policy tool. (II – all, II.13, 14) How does Bagehot evaluate the Bank of England’s use of reserves? Based upon this critique, what approach to reserves does Bagehot advocate?

4. Bagehot (I.8) argues that “commercial morality” has declined to the “dirty crowd of little men” and this decline has changed the incentives that shape banking. What implication does this evolution in informal institution have for central banking in the form of the Bank of England? For central banking in general?

5. Bagehot uses the phrase “natural system of banking” (IV 6). How does he use this phrase to understand the costs and benefits of central banking?

6. Bagehot explores financial leverage and capital mobility. (I.11 and I 14) ) Both of these issues have come under contemporary scrutiny and are “addressed” by Dodd Frank. What costs and benefits to leverage and mobility does Lombard Street analyze and what conclusions does Bagehot offer based upon this analysis?

7. Bagehot makes a distinction between domestic and foreign deposits and the risk offered by each. (II.16 and 30-33) What implications does Bagehot describe as a result of this distinction and what are the differing consequences? Does the “solution” or “plan” offered by Bagehot in his conclusion mitigate these consequences?

8. FA Hayek calls the price system a “marvel” in part for the information included in price. (Use of Knowledge in Society). Bagehot seems to anticipate Hayek in his use of bank profit as a signal of risk and stability (II.21-23). What are the tradeoffs that Bagehot identifies in this risk/stability tradeoff? How has this tradeoff been resolved in the past and what challenges does Bagehot see for future resolution of this tradeoff in England?

9. Bagehot describes panic as “a series of neuralgia, and according to the rules of science you must not starve it.”(II.41). euralgia is pain in one or more nerves[1] that occurs without stimulation of pain receptor (nociceptor) cells. Neuralgia pain is produced by a change in neurological structure or function rather than by the excitation of pain receptors that causes nociceptive pain. How useful is this metaphor in understanding a bank run and why does Bagehot argue that is must not be starved or eliminated?

10. Bagehot writes: “New wants are mostly supplied by adaption, not by creation or foundation”(III.2). How does this assertion shape Bagehot’s analysis and his recommendation for improving the BOE? Note: This question can be repeated in the second discussion when considering Dodd Frank.