No. 226 - Confidence Costs and the Institutional Genesis of Central Banks

This paper revisits the history of central banks from an institutionalist perspective. The analysis rests on a theory of money that stresses the means-of-payment function as well as the institutional character of money. The evolution of central banks is seen as being driven by the need to devise institutional safeguards to sustain the public's confidence in increasingly abstract payment technologies, whose main appeal greater flexibility of money supply - is also their main drawback, since it entails a higher risk of abuse on the part of the supplier. The evolutionary process of central banks can be divided into three main phases, respectively associated with the spread of the convertible banknote, deposit banking and fiat money. In each phase, the institutional safeguards that eventually prevailed reflected not only the objective properties of the new payment technology, but also popular beliefs and existing legal and political institutions. Adaptation to the challenges posed by the rise of fiat money - based on a more precise definition of the objectives to be pursued by central banks and of their sphere of autonomy with respect to both the Executive and Legislative powers - is still under way. In this regard, it is argued that in view of the inherent complexity of the social function performed by central banks mechanical rules are not likely to provide satisfactory guidance for their action. Effective central banking will continue to be inextricably associated with the notions of ex-ante "discretion" and ex-post "accountability".