Product Overview

On October 25, 1847, British prime minister John Russell met with his cabinet to review a deepening financial crisis and to weigh proposals for government response. Chief among these were two proposals. The first was to suspend the Bank Charter Act of 1844 in order to permit the Bank of England to discount more freely and to issue banknotes in greater volume than the Act allowed. In recent days, delegations of merchants, industrialists, and country bankers had approached Russell to plead for more currency. The second was to do nothing and allow the crisis to run its course. Some members of Parliament argued that the whole point of the Act was to impose discipline at times like this, so to suspend it would make a mockery of that discipline and create moral hazard. As leaders of the Whig Party, Russell and his cabinet would need to navigate carefully through the crisis, owing to the slim majority his government held in Parliament. The A case (F-1930) describes five shocks that promoted the financial crisis of 1847—agriculture, railways, demand, monetary, and fiscal—as well as the complicated political situation at this time of the Irish potato famine. This B case offers an epilogue.

Learning Objectives

(1) Exercising the concept of the "impossible trilemma" to understand why Russell's government found itself in this crisis position, and to outline some of the classic policy responses. Evidence suggests that the crisis was characterized by "commercial distress and financial panic, the extremity of which was remarkable" in the words of Rudiger Dornbusch and Jacob A. Frenkel. (2) Identifying central bank "sterilization" of cross-border capital flows. (3) Reviewing the pivotal nature of the Bank Charter Act of 1844 and the ways in which this law created unintended consequences, namely promoting credit expansion to create stock market speculation, and limiting the flexibility of the Bank of England. (4) Considering the pros and cons of flexible monetary policy and the role of lender of last resort. The suspension of the Act is an important point in the history of central banking, as it represents one of the earliest (perhaps the first) official government action as a lender of last resort. (5) Surveying the history of the financial crisis of 1847, which proved highly influential in shaping public-sector responses to subsequent financial crises in Britain and the United States.