The 1825 crisis was severe and triggered policy changes that would be important to Britain’s dominant role in global finance over the 19th century. These policy changes included the lifting of limitations on forming joint-stock corporations (Quinn and Turner 2020, 56), the promotion of joint-stock banking, and the adoption of branch banking by the Bank of England (Quinn and Turner 2020, 56; Neal 1998, 53). The typical focus on specific post-crisis policy changes understates, however, the full implications of the 1825 crisis for economic thought. The 1825 crisis was one of the first to combine a financial market crash with a banking crisis. This demonstrated clearly the financial, banking, and real economy interconnections that had developed in an economy with a newly established bank-based payments system. Having made these linkages evident, the crisis laid important foundations for the development of macroeconomic thought.

The elements of a bank-based payments system in England had been established by the early 1800s (Sissoko 2022) and with this development the economy had started experiencing business cycles (Gayer et al. 1975). In this environment, when the Bank of England Note issuance expanded or contracted, the effects throughout the country could be dramatic. This paper discusses two such events: the 1821 withdrawal of small Bank notes which was a significant monetary contraction, and a dramatic overnight monetary expansion in October 1824 that was withdrawn over the following months, whipsawing the economy monetarily and terminating in the 1825 crisis. These serious mistakes of monetary policy had the effect of making clear certain basic macroeconomic principles, including the “multiplier effect” and the importance of central bank management of the money supply.

Thus, the 1825 crisis consolidated an understanding of the business cycle as a phenomenon that was both profoundly affected by central bank policy and closely associated with fluctuations in the circulating liabilities of banks. It made transparent that there was a business cycle and that variations in the money supply had significant influence over the cycle. The distinction between base money and broad money was drawn, the concept of a multiplier was developed, and the multiplier was understood to break down in a panic. More particularly, the directors of the Bank of England came to a completely new understanding of their role in the economy, and of the essential importance of both managing the money supply and keeping a close eye on the broader banking system.

These findings are developed by drawing new insights from two primary sources, the meeting minutes of the Bank of England’s Court of Directors (abbreviated C.D.) and the 1832 Report of the House of Commons committee (abbreviated H.C.) that was appointed to investigate the renewal of the Bank of England’s charter — in particular what conditions it might be appropriate to add to such a renewal. The 1832 Committee was thorough and provides highly detailed data on the Bank’s activities in 1825. This work expands on Clapham’s (1945) and Fetter’s (1965) use of the directors’ minutes to exposit the history of the Bank by focusing very closely on the period from 1821 to 1825 and by documenting events such as the withdrawal of small notes that are not well known. While the testimony and data in the 1832 Report has been used by many scholars, this paper focuses in particular on the testimony, demonstrating theoretic advances in macroeconomics which to our knowledge has not been explored by others.

This paper expands on the current literature on the 1825 crisis including Neal (1998), Cheong (1973), and Turner (2014). It is most closely related to King (1972, 38), who emphasizes the role played by the crisis in the Bank of England’s development as a central bank by transforming its management of note issues and reserves. In this paper, however, the focus is how the crisis was driven by both the development in England of a bank-based payments system, where bank liabilities comprise a significant portion of the circulating money supply, and by the challenges that the Bank of England faced in understanding its role in that new system. Thus, the emphasis here is on how macroeconomic theory is developed through a process of learning from mistakes.1 In contrast to Gayer et al. (1975, 207), who remark that critics of the Bank’s expansionary policy imply “foresight and initiative on the part of the directors to a degree to which few twentieth-century central bankers could lay claim, but also a theory and technique of central banking which is not to be associated with Britain in the first half of the nineteenth century,” this paper argues that the 1825 crisis was a crucial step in the development of the theory and technique, not just of central banking, but also of macroeconomics itself.

This paper is also related to the literature on central banking and the evolution of monetary policy. Bindseil (2019) and Kosmetatos (2018) focus on the early history of central banking and thus this paper extends their studies by exploring a later period and explaining the role of the central bank in anchoring a bank-based payments system (see also Sissoko and Ishizu 2025). While Ugolini (2017) explores the evolution of monetary policy in the form of discount window lending and interest rate policy, this paper expands on this by studying the fundamental principle of the need to stabilize the money supply.

Section 1 sets the stage, describing the post-war context in which the crisis arose, and in particular, the banking environment. Section 2 explores the 1821 pre-crisis withdrawal of small notes and the Bank’s mismanagement of this process. Section 3 focuses on the 1824 debt conversion and its effects on the money supply. Section 4 discusses the country bankers’ experience of the crisis. Section 5 explains how the crisis was a turning point for economic thought both within the Bank and in the broader economy. Section 6 concludes.

The Early 19th Century Economic Environment and Normalization after the Napoleonic Wars

By the early 1800s the elements of a bank-based payments system were already present in England. In particular, outside of London the payment system functioned in a manner directly analogous to 20th century checking accounts or modern e-payments. In wholesale transactions, commercial payments were made by a bill drawn on a professional financier, and this bill was typically deposited directly in the recipient’s local bank account for immediate credit to the account (Sissoko 2022).2 The bank would manage the process of claiming payment from the financier upon whom the bill was drawn. To pay workers, businesses would obtain bank notes from the local bank which then circulated as a retail means of payment (Pressnell 1956, 153–5). In short, in early 19th century England economic activity was undergirded by a system of bank credit that was very similar to banking as we understand it today.3

At the same time the British economy had begun to experience the economic fluctuations associated with the credit cycle that are familiar to us today as the business cycle.4 The banking system and the credit cycle were, however, sufficiently novel that they were not well understood. More precisely, the potential effects of an expansion or contraction of high-powered central bank money on financial markets or the economy as a whole were not yet established — and were mysterious, in particular, to the directors of the Bank of England who were responsible for managing the high-powered money supply. This paper finds that it was the mistakes of the 1820s that demonstrated these basic macroeconomic principles.

By 1810 the Bank of England’s directorship had already acknowledged — in private at least — a duty to the public that encompassed the support of the country’s commercial activity (Duffy 1982; Sissoko 2016; Sissoko 2022). Thus, the problem was not that the Bank directors were indifferent to the Bank’s de facto public responsibilities. It was instead that a banking system that was tightly integrated with the Bank of England had grown up over the course of the Restriction, and the directors had to learn the basic principles of monetary policy from scratch. As a result, there was a tendency for the Bank to make mistakes in this period, but also a fast learning curve.

The other factor that defined the environment in 1820s England was the process of normalization that was taking place following the end of Napoleonic Wars. At the end of the war in 1815 legislation established that the first order of business for the Bank was to steer a course towards resumption of the convertibility of the Bank note. This required reducing the Bank notes outstanding and a corresponding reduction in the Bank’s lending activities. Alongside the decline in lending, the Bank’s income fell and the challenge of offsetting this decline would become an important topic at the directors’ meetings.

More specifically, the Bank reduced its lending by restricting its discounts and provision of credit to the private sector. Immediately after the peace was signed the Bank set firm credit limits — or “private marks” — on each account (C.D. August 31, 1815).5 As the market rate of interest fell to 3% while the bank held its discount rate steady at 5%, the Bank was very successful in reducing the discounts, which dropped by 85% from the third quarter of 1815 to the end of 1817 (H.C. 1832 Apps. 56 and 58).

While the new discount policy reduced the Bank’s income, up until 1818 an increase in the Bank’s advances to the government on Exchequer Bills offset the decrease in commercial bills discounted to some degree (Clapham 1945, vol. 2, 64). However, after 1818 the government was reducing its debt, and through mid-1821 the outstanding Exchequer Bills held by the Bank that were related to the wars were steadily paid off.

After the Bank successfully resumed convertibility in May 1821, the problem of generating income for the Bank loomed ever larger.6 Just two years earlier the Bank had been demanding that the Government redeem the post-war Exchequer Bills. Post-Resumption the directors’ attitude changes dramatically and we find that the post-war Exchequer Bills still outstanding in June 1821 are exchanged for new Exchequer Bills and carried into 1822. This exchange process continues through 1825 (H.C. 1832 App. 70).7 Furthermore, discussions about the Bank’s income and how to increase it began to appear with regularity in the minutes. To increase the discounts, the Bank began to accept bills of three month rather than two-month tenor (C.D. December 20, 1821). The discount rate was lowered to 4% (C.D. June 1822). Further reductions in the discount rate and extension of the tenor of bills discounted were proposed, but rejected (C.D. May 8, 1823; May 15, 1823; June 19, 2023; Jan 29, 1824; June 10, 1824). The Bank purchased Exchequer Bills on the public market, but stopped when they began to trade at a premium (C.D. Sept 26, 1822; Nov 28, 1822, 207; May 29, 1823).

In the meanwhile, the Bank had been accumulating gold reserves. Reserves topped out at £14 million in December 1823 (H.C. 1832 App. 28) and would not reach that level again for 20 years.

To summarize, in order to resume convertibility, the Bank of England reduced its balance sheet from its high in 1816 by 25%, reaching a low in 1822. At the same time, the Bank more than doubled its coin and bullion holdings. This was accomplished on the asset side of the balance sheet by a dramatic decline both in the Bank’s discount business and in the Bank’s advances to the government (see Figure 1). While the Bank sought to increase its lending after Resumption, the Bank found doing so to be difficult and slow.

Figure 1
Figure 1

Bank of England Assets.

Source: Hills, S., R. Thomas, and N. Dimsdale (2015, A23).

The dramatic monetary contraction of 1821: the withdrawal of small notes

Even though the Bank resumed convertibility in May 1821, the recession associated with the monetary contraction extended into 1822 and the domestic price index reached a record low in May 1822, approximately 20% lower than the price index at Resumption a year earlier (Gayer et al. 1975, 177).8 This is easily explained as a policy mistake of the Bank.

Observe that from February 1821, three months before the Resumption, to February 1822 the Bank’s balance sheet shrank by £5.6 million or 12% and the decline was driven by a decline in the Bank’s note issues (see Figure 2). As half of the decline takes place after Resumption was successful (H.C. 1832 App. 5), this seems puzzling. In fact, it is explained by the way the Bank managed its small notes.

Figure 2
Figure 2

Bank of England Liabilities.

Source: Hills, S., R. Thomas, and N. Dimsdale (2015, A23).

The law governing Resumption did not only require that the Bank restore the convertibility of the Bank note, but also required that all £1 and £2 notes be taken out of circulation within two years after convertibility was restored. Since more than a quarter of the Bank’s circulation was made up of such small notes, this was a major undertaking. Thus, the massive reduction in the Bank’s balance sheet from 1821 to 1822 is explained by the liability side of the Bank balance sheet: the Bank withdrew £5.2 million small notes from circulation with extraordinary speed (see Figure 3). This caused the circulation of Bank notes in aggregate to decline by over 20% from May 1821 to November 1821 (H.C. 1832 App. 83). On the asset side of the balance sheet, all of the asset categories aside from long-term government debt declined from 1821 to 1822.

Figure 3
Figure 3

Bank of England small note circulation.

Source: From H.C. 1832 App. 83.

At the same time that the Bank was rapidly withdrawing its small notes, the country banks were also preparing for the complete withdrawal of small notes. It is thus hardly surprising that by mid-1822 nominal GDP had dropped to its lowest level in 15 years (Hill et al. 2015). Because of the dramatic decline in prices, however, real GDP actually increased slightly: Tooke (1838, 84–85) reports a “depression in the average price of wheat” that took place “down to the close of 1822.”9 The inhabitants of Manchester and Salford complained of the challenges of “secur[ing] a satisfactory currency” and specifically attributed the problem to “the cessation of the issue of small notes by the Bank of England” (Morning Chronicle August 30 1821). As always, the burden of deflation fell more heavily on certain sectors of society, and one of the Bank directors describes the experience of the agricultural districts as depression (H.C. 1832: Q2015).

In July 1822 the government delayed the redemption of small notes by ten years in order to restore commercial activity and “revive speculation” (H.C. 1832: Q2015). By this time, the Bank had already redeemed 85% of the small Bank notes that it had had outstanding at the time of Resumption. Despite the shift in the law the Bank of England continued to slowly withdraw small Bank notes from circulation. On the other hand, the government’s policy extending the circulation of small notes for a decade facilitated the growth of country bank notes.

The Bank is almost certainly responsible for the consequences of precipitously withdrawing its small notes from circulation. In matters such as this, the Government typically took the Bank’s advice, and thus a request from the Bank to slow the withdrawal of the small notes would likely have been met with a law authorizing the change. Furthermore, the Bank’s decision to reduce the small notes by almost 70% and the total notes in circulation by more than 20% over the six months leading up to November 1821 was wholly the Bank’s responsibility, since the original legal deadline for redemption was May 1823. The consequences of the policy appear to have been sufficiently severe to induce the Government to respond to the economic situation by delaying for a decade the policy requiring the redemption of small notes, and thereby relaxing the constraints on the money supply — much to the consternation of the Bank directors.10

The Bank directorship almost certainly did not understand in 1821 that this abrupt reduction of the circulating notes would cause significant economic disruption. They may have fallen prey to the bullionist view that bank notes are simply substitutes for gold, imagined that a £1 coin could play the same economic role as a £1 note, and thus concluded that there would be no monetary consequences to replacing the small bills with gold coin.11 They could have drawn this conclusion, even though they understood that Bank notes served as the high-powered money of the London financial community and thus played a role very different from that of gold coin, because the small notes did not play this role, but instead circulated among “the lower classes of society” (H.C. 1832: Q2304). Certainly, the directors did not understand that their policies might have a multiplier effect with respect to the circulation in the countryside: in 1832 one of the directors explains that the Bank did not understand the importance of the country bank circulation to monetary policy in the early 1820s and furthermore had no data on that circulation (H.C. 1832: Q1909).

In short, the first major error of monetary policy that served to set the stage for the 1825 crisis was the Bank of England’s abrupt withdrawal of its small notes from circulation in 1821. This apparently had a multiplier effect that resulted in severe distress in the countryside, and caused the government to intervene by relaxing the constraints on country bank notes.

The 1824 Debt Conversion and its Consequences

In 1823 and through much of 1824, economic activity generally appeared to be healthy. By the end of 1824, however, not only were there growing concerns that the economy was overheating, but also signs of a bubble on the stock market were appearing. The evidence indicates that the expansion of the Bank’s circulation was a determining factor in the boom-bust cycle.

Through 1823 and early 1824 the Bank was actively seeking means of increasing it income through lending. Subsequent to the government’s shift in policy in 1822, the country banks’ small notes no longer needed to be redeemed. This left the Bank with an unexpected excess of gold and in an awkward position (H.C. 1832: QQ1968–69, 1975; Q4958). There was no reason to continue constraining the growth of the Bank’s balance sheet by restricting investment in income-bearing assets. Indeed, the gold reserve was so large, that monetary principles at the time indicated that the Bank should increase the notes in circulation and therefore buy assets (H.C. 1832: Q1968). The difficulty was that the two traditional categories of income-bearing assets were not available on the Bank’s customary terms: the government budget was tending towards surplus, so the Bank’s short-term government lending was reduced, and market interest rates continued to hover below 3.5%, so the Bank’s discount business — since June 1822 offered at 4% — was moribund. To expand the circulation as economic circumstances demanded, the Bank was going to have to adjust its lending policies.

As was discussed above, the Bank took only very slow and incremental steps to expand the Bank’s investments. In mid-1823 the Bank offered 12 month loans at 4% against the security of Bank stock up to 75% of the market value of the stock (C.D. May 22 1823). But the incremental measures were ineffective.12 At the end of 1823 the Court approved a policy of lending up to £2 million on mortgages. By mid-1825 the Bank had lent out £1.5 million on mortgages. The business was not allowed to grow after July 1825, and it was finally formally put into run off mode in October 1826 (Clapham 1945, vol. 2, 82–84; H.C. 1832 App. 6).13

In mid-1824 the Bank began to offer “advances” or loans of six months secured by government debt or Bank stock and loans of three months secured by ”approved” bills. ”Approved” bills were issued by the government, East India Company, or met the Bank’s standard discount criteria except that their maturity extended beyond three months (C.D. June 24, 1824). These loans reach £1.8 million by December 1824.

In addition to the private loans, the Bank was also able to provide short-term loans to the government which sought to reduce the interest burden of the debt that had been incurred during the wars. This conversion was possible because the debt was callable and could therefore be paid off in full at any time. Thus, the government converted the wartime debt to debt at a lower interest rate by offering a voluntary debt conversion and by paying off in full all “dissenters,” that is, those who chose not to accept the debt conversion. The funds to pay the dissenters were borrowed from the Bank using Exchequer Bills and the Bank loan was paid off via eight quarterly payments over the course of the subsequent two years.

The first loan supported the conversion of a 5% debt issue into 4% debt. A Bank loan of £2.6 million used to pay the dissenters was made on July 5, 1822 and paid off over the course of the following two years (C.D. March 24, 1822). Notably, this loan did not actually have much effect on the Bank’s holdings of Exchequer Bills, because of a similarly timed decline in the Exchequer Bills that the government used regularly to manage its cash flow from taxes. This shift in cash flow needs reflected the surpluses the government was experiencing.

The second debt conversion was more aggressive. It sought to convert a war-time 4% debt issue into 3.5% debt — at a time when the debt was trading on the market at a yield above 3.5%. This unsurprisingly resulted in a large number of dissenters. The government budget was however in surplus, so the government was confident that it could easily pay off a conversion loan of £6 million in quarterly payments over the course of two years. The Bank of England also apparently did not expect any problems to arise from such a loan, presumably because the first conversion loan had gone so smoothly.

Thus, on October 10, 1824, the Bank paid £6 million to the dissenters (C.D. July 1, 1824).14 In contrast to the first conversion, there is no offsetting reduction in Bank lending.15 Not until December is some of this liquidity withdrawn when the government uses its tax revenues to redeem £1 million in older outstanding Exchequer Bills (1832 Report App. 65). In January 1825 the first payment of £750,000 to redeem the conversion loan was made. This pattern of withdrawing £1.75 million in Exchequer Bills continues for two more quarters through June 1825.

As is explained in Sissoko (2018), this October wave of liquidity paid to investors in government debt had dramatic effects on the stock market stimulating an extraordinary wave of new issues. Prior to 1824, 156 joint stock companies had been established. Well over that number of new companies, specifically 245, raised money on the stock exchange from 1824 to 1825. Of these only 127, or just over half, were still in existence in 1827 (English 1827, 30–31).

The effects of the monetary stimulus were unsurprisingly not limited to financial markets.16 There was a boom in the construction of new mills in Manchester, with many projects left abandoned and incomplete in the bust (Gayer et al. 1975, 198). The production of bricks and the import of timber peaked in 1825 with amounts 20–33% higher than in 1824 (Gayer et al. 1975, 186). From October 1824 there was a six month boom in foreign trade as evidenced by a commodity import boom which peaked in May 1825 and was followed by a dramatic decline over the next 14 months (Gayer et al. 1975, 179, 182). In the meanwhile exports of cotton manufactures peaked in 1824, stayed fairly stable in 1825 and declined in 1826, reflecting the domestic character of the boom (Gayer et al. 1975, 196).

Alongside the import boom, the price of cotton nearly doubled from November 1824 to June 1825 and then by June 1826 had fallen 18% below its price in November 1824 (Gayer et al. 1975, 181). Such dramatic price movements in core commodities necessarily resulted in challenging environment for business, and by the middle of 1825 there was increasing demand at the Bank of England’s discount window. The Bank’s active discount lending was not however sufficient to offset the effects of the £4.5 million in liquidity that was withdrawn from the economy from December 1824 to June 1825. Bankruptcies began to occur especially in Liverpool with its close connection to the cotton trade (Tooke 1838, 156). These business failures spread over the next few months, and in December 1825 there were more than 200 bankruptcies and six London banks stopped payment including Pole Thornton & Co, which had correspondents throughout the country (Pressnell 1956, 487). The very elevated level of more than 200 business bankruptcies per month would continue through June 1826 (Gayer et al. 1975, 205).

Although the Bank had restricted its discounts in November, by mid-December it completely shifted its approach and was lending creatively and aggressively to support the business community. Measures taken by the Bank included: the purchase of Exchequer Bills to support their price and more particularly their use as “safe assets” by bankers; exceptional lending secured by consols and Bank stock; exceptional loans secured by bills that were not eligible for discount; and exceptional loans secured by goods (Sissoko 2018).

The Country Banker’s Experience of the 1825 Crisis

Despite the extraordinary lending measures adopted by the Bank, as many as 80 country banks stopped payment (Gilbart 1837, 110).17 Indeed, much of the literature on English banking in this era has focused on the high failure rates of country banks, and the 1825–26 crisis, which saw the highest rate of country bank failures, provides the strongest evidence for these claims.18 Many authors extrapolate from this failure rate to the existence of significant losses to the non-bank public due to bank failures (Calomiris and Haber 2014, 103; Temin and Voth 2013, 36–7).19 It is worth, however, considering more carefully who bore the greatest losses from the 1825–26 crisis and the bank failures associated with it.

Pressnell (1956, 491) finds that of the country banks that stopped payment during the 1825–26 crisis, by June 1828 a third had already resumed business after paying in full and only 9 were unlikely to pay their creditors in full. This is confirmed by Henry Burgess’ (H.C. 1832: Q5175) testimony in 1832: only about 30 country banks failed to resume business after 1825, and of these many paid in full. Cottrell and Newton (1999, 82) find that only 5 country banks failed to pay in full.

Furthermore, Pressnell (1956, 495–6) makes it clear that interconnectedness within the country banking system caused contagion effects that drove many country banks to stop payment during the crisis: one mismanaged bank could easily cause four more banks to suspend payments. On the other hand, the same interconnectedness also ensured that most of the losses due to a failed bank fell on other banks that were exposed to the failed bank’s liabilities.

In short, the evidence indicates that the vast majority of banks that failed during the 1825–26 crisis made their creditors whole and that the few that did not do so, still paid about 90% of what was owed (Hansard 1828). This conclusion should not, however, be read to imply that the losses associated with the crisis were minor. On the contrary, the losses due to the crisis were significant. The point that has been lost in modern discussions of the crisis is that the bulk of the losses fell on the bankers themselves, not on the non-bank public. One country banker reported that he lost £10,000 on the sale of securities in order to honor his obligations during the crisis (H.C. 1832: Q1656). Given that Exchequer bills, which were some of the safest assets held by country bankers, were trading at a 15% discount during the crisis and would have traded even lower without Bank of England support (H.C. 1832 App. 65; C.D. December 13 1825), this banker’s experience was probably fairly typical. Indeed, the 1832 Committee when inquiring into the losses to the public likely to be associated with the new joint stock banks, focuses almost entirely on the losses to the public as shareholders in joint stock banks, not as creditors of joint stock banks (H.C. 1832: QQ3735–38; QQ5291–94).

Pole Thornton & Co. may be a good example of the costs incurred by banks that stopped payment. The personal estates of Pole Thornton’s partners had to be signed over to the Bank of England and legal control of them was not recovered for a full six years after the crisis.20 This, even though Henry Pole was extremely well-connected – so that the Governor of the Bank had to recuse himself from matters associated with Pole Thornton (Clapham 1945, vol. 2, 99). Of course, the owners of the few banks that failed to pay their creditors in full had to sell their estates, so Pole Thornton’s partners were in that sense fortunate.

In this environment, the number of private banks continued its secular decline (Garnett et al. 2015) and those that stayed in operation retrenched, adopting more conservative business practices.21 Unsurprisingly the 1825 crisis was followed by years of industrial stagnation (Gayer et al. 1975, 241).

1825 crisis as a turning point for macroeconomics

The crisis fostered significant shifts in the understanding of money and its interactions with the broader economy both at the Bank and in the business community more generally. The Bank went into the 1825 crisis with only two rules of thumb to govern its activities. First, to constrain the size of the gold reserve there was a not-at-all-binding principle that the amount of bullion should amount to about one-third of the Bank’s liabilities (H.C. 1832: QQ4963–64; Q1904). Second, as had been established by the Bullion Committee in 1810 another principle was that, when the exchange rates with foreign countries were generally unfavorable and remained so, this was a clear indicator that the Bank’s liabilities needed to be reduced.22 In the decade following the crisis, the Bank would take active measures to stabilize the money supply, and its directors would express a clear understanding that there was a business cycle which was affected by the Bank’s note circulation, as well as an understanding that the high-powered money issued by the Bank was subject to a multiplier as the rest of the banking system extended its issues with direct effects on economic activity.

The Bank of England Learns to Stabilize the Base Money Supply

Prior to 1825 it is abundantly clear that the Bank of England did not understand the economic consequences of dramatic shifts in the circulating note issue (which at this time determined the shift in the aggregate amount of the Bank of England’s circulating liabilities, as deposits were relatively small and by comparison stable) (see Tooke 1826, 67–71). This is evidenced by the Bank’s actions: first, the precipitous withdrawal of small notes in 1821 to 1822, and, second, the disastrous 1824 debt conversion loan. We find that after the crisis the Bank’s directors adopted policies that stabilized the money supply over the stringency that occurred on a quarterly basis. This is clear evidence that the crisis had an effect on the Bank directors’ understanding of their role, especially as these policies were maintained into the 20th century.

To be more specific, after the 1825 crisis the Bank of England adapted one of its innovative lending policies from 1824 into a facility that could be used to stabilize the base money supply over the “shuttings.” The shuttings took place in every quarter when the ledgers of holders of government debt that the Bank maintained were temporarily shut to transfers while the Bank paid out the interest due on the debt. The pattern of tax revenue inflows and interest payments affected the money supply because over the course of the quarter tax revenue flowed into the Bank as it was paid, reducing the circulating money supply, and then after the shuttings when interest was paid on the debt the circulation increased again. Since taxes were due in the first week of the first month of each quarter and interest on the debt was paid in the middle of the month, the amount of change in the note circulation over these two weeks could exceed 20%.23

In December 1829 the Bank adapted the loan facility from 1824 that took as collateral commercial bills, Exchequer bills and East India bonds to make loans of up to six weeks during the shuttings (C.D. December 3, 1829). This facility issued over £1 million in loans (H.C. 1832 Apps 26 & 27) and became an institution that was available quarterly even into the early years of the 20th century.

Theorizing the Business Cycle and the Multiplier

In the two decades following the crisis, an understanding of basic macroeconomic phenomena such as the business cycle, the effects of the Bank’s policies on the business cycle, and the money multiplier begin to be clearly expressed. Thus, it is unsurprising that the boom “that reached its climax in 1825 has often been referred to as the first truly modern cyclical boom in British economic history” (Gayer et al. 1975, 171).

The macro-economist most commonly associated with this period is Thomas Tooke, who wrote a six volume History of Prices and of the State of the Circulation from 1792 to 1856 and is recognized as one of the first macroeconomic statisticians. While Tooke focused primarily on price series and studied in detail how they were shaped by supply and demand in various markets, Tooke also emphasized the effects of the circulation of the Bank of England’s notes on these markets. In this process, Tooke documented business cycles and took a multicausal approach to explaining them. In addressing the 1825 crisis, Tooke saw clearly that the severity of the crisis was driven by a failure on the part of the Bank to recognize that its lending activities in late 1824 which dramatically increased the circulation of Bank notes needed to be offset by countervailing policies that would absorb Bank notes (Tooke 1838, 178–80).

Tooke’s advances in understanding reflected an environment where the macroeconomic effects of the 1825 monetary expansion had been experienced and witnessed by many observers. Indeed, “fluctuation in the value of money” was an important topic investigated by the 1832 Committee, precisely because they were concerned about its economic implications (H.C. 1832: QQ1708, 3610–14, 5336–40, 5797).24 A stock broker who testifies to the Committee lays responsibility for the boom and bust on financial markets squarely on the Bank’s shoulders: like Tooke he believes that the Bank should have taken measures to sterilize the monetary expansion of autumn 1824, because “it surely is proper and fair that the Public should require some security against an appearance of things which naturally induces people, without having the same means of knowledge as Bank Directors, to go into those speculations by which they become ruined” (H.C. 1832: Q5799). He continues to describe the Bank’s actions as “something like setting a house on fire, and then finding the necessity of putting it out” (H.C. 1832: Q5802), and is adamant that he could not “find any person, unconnected with the Bank, that appears to have a doubt about” the fact that the Bank was responsible for the disruption of financial markets.

In this environment it is unsurprising that a Bank director testifying to the same Committee discusses clearly the business cycle, and connects it to a money multiplier effect on the broader banking system.25 After noting that he “could give an opinion upon it at the present moment that I could not have given at the time,” William Ward observes: “There seems to have been for the whole period since the Peace a system of that kind of fluctuation, which is, I think, very much to be regretted, but the whole causes of which we do not always know at the moment.” Ward goes on to relate these economic fluctuations to changes in the “country circulation” which the Bank was only just beginning to monitor (H.C. 1832: Ward Q1909). He makes it clear that the Bank also recognizes the influence of the Bank on the country bank circulation (H.C. 1832, Q1909; see also QQ5334–38), recognizing the distinction between the high-powered money supply which was within the control of the Bank of England and the broader bank-based money supply, which could only be influenced and not entirely controlled by the Bank.26

Henry Burgess (H.C. 1832: QQ 5329–36), the Secretary of the Committee of Country Bankers, explains the multiplier to the 1832 Committee even more clearly.27 In particular, he explains that bills of exchange comprised as much as 90% of the monetary circulation in the manufacturing districts. This circulation was very sensitive to the Bank of England note issue with a multiplier well in excess of one (H.C. 1832: Q5334). Due to the monetary role of these bills “a great and sudden diminution of their amount operate[s] materially upon prices, and produce[s] all the distress usually attendant on sudden contractions of the currency” (H.C. 1832: Q5336). In short, a decrease in Bank notes leads to a decrease in bank credit – which is extended in the form of commercial bills particularly in the manufacturing districts. This decline in the bank credit available to manufacturers reduces their access to working capital and ultimately reduces economic activity and pushes prices down. An increase, of course, has the opposite effect.

Theorizing the Lender of Last Resort

The 1825 crisis also consolidates the understanding of the theory of the lender of last resort that was so lucidly explained by Thornton ([1802] 1965) and by the Bullion Report (H.C. 1810). When the 1832 Committee investigates the 1825 crisis, the duties of a lender of last resort are discussed in the clear language distinguishing a domestic drain from a foreign drain that was established by Thornton. One of the 1832 Committee members asks:

the Bullion Report of 1810, there is the following proposition, “a distinction most important to be kept in view between that demand upon the Bank for gold for the supply of the domestic channels of circulation, sometimes a very great and sudden one, which is occasioned by a temporary failure of confidence, and that drain upon the Bank for gold which grows out of an unfavourable state of the Foreign Exchanges; the former, while the Bank maintains its high credit, seems likely to be best relieved by a judicious increase of accommodation to the country.” Does that appear to you a judicious statement of the prudent management of the Bank? (H.C. 1832: Q5368)

The respondent concurs. Jeremiah Harman, a senior Bank director, expresses a similar opinion (H.C. 1832: QQ2254, 2261, 2271).

In his testimony Bank director William Ward extends this by stating clearly the principle of central bank lending in crises that Friedman and Schwartz (1963) would emphasize more than a century later: the reason that emergency central bank lending does not create problems, but instead solves them, is because it offsets a reduction in the money supply due to the crisis. In response to a request for an explanation of why the emergency issues of the Bank in a crisis do not constitute an improper expansion of the money supply, he stated: “in December the circulation of the Bank became enormously increased, but the credit of the country became more than proportionably reduced, therefore the momentum of the two was different from what would have been supposed” (H.C. 1832: Q2085).

Jeremiah Harman also makes a point that would later be expressed clearly as a principle of last resort lending by Walter Bagehot. During the 1825 crisis the Bank continued to issue Bank notes, despite the fact that for a day or so it appears to have literally run out of gold in the till (Sissoko 2018). Harman describes the Bank’s actions through this crisis as “an effort to stop the plague” (H.C. 1832: Q2222) and “I think we were within an ace of the whole effort failing to save the credit of the country” (H.C. 1832: Q2262). King (1972, 37) echoes this assessment describing the crisis as bringing the country to “within 24 hours of barter.” Bagehot ([1873] 1999, 97) frames the principle underlying this behavior: aggressive lending is necessary to protect the banking system when it is in crisis: “The only safe plan for the Bank is the brave plan, to lend in a panic on every kind of current security, or every sort on which money is ordinarily and usually lent. This policy may not save the Bank; but if it do not, nothing will save it.”

Conclusion

The transformation of the British economy and of its financial structure after the disastrous bank failures of the 1825 crisis is well established. This paper extends this history by focusing specifically on the role that the recent development of a bank-based payments system in England played in the crisis. We have found that the onset of macroeconomic cycles coincided with the development of the banking system and we demonstrate that the 1825 crisis, because of its severity and because of the lived experience of a dramatic monetary boom-bust cycle, was a turning point in macroeconomic understanding. We demonstrate that prior to the crisis in two cases the Bank allowed the unnecessary shifts in the circulating money supply to cause economic dislocation, and that after the crisis the Bank took active measures to stabilize the money supply. This paper also finds that the crisis — and the banking system’s role in the crisis — led to substantial advances in macroeconomic theory.

Notes

  1. Note that some of this literature seeks to use the 1832 Report to apportion blame for the crisis on the country banks (e.g. Quinn and Turner 2020, 53 footnote 68). Thus, it is worth noting that the authors of the 1832 Report decline to “giv[e] a decided opinion” on questions regarding the circulation of bank notes and their proper management, but instead refer readers to the witness statements in the evidence (H.C. 1832, 3). 1832 witnesses who blamed the Bank of England include (H.C. 1832: Stuckey Q1083, Loyd Q3466–71, Tooke Q3852, Burt QQ4446–49, 4454, Easthope Q5799, see also Palmer Q120). 1832 witnesses, Gurney Q3763 and Atwood Q5778, absolve the country banks without blaming the Bank of England. [^]
  2. Because bills typically were only payable after a month or two, this was an accommodation offered by the bank. In the event that the bill was not paid when due, the bank could withdraw the funds from the account. [^]
  3. In London, bills could not be deposited for immediate credit into a bank account, but would only be credited after the bill matured (Sissoko 2022). Presumably the accessibility of discount facilities in London at both the Bank of England and private houses ensured that this was not a significant constraint for London businesses. [^]
  4. On the credit cycle, see Hawtrey 1919; on the business cycle, see Gayer et al 1975. [^]
  5. The accounts are divided into five categories with different limits that are to be revised annually by the Discount Committee. When bills and notes are considered for discount, the clerks are to include notations on the total outstanding on the discounter’s account and on the relevant credit line. [^]
  6. Note, however, that the Bank was still obliged to continue accumulating gold in order to be able to redeem all the small notes including country bank notes by mid-1823, a requirement that was postponed for a decade in July 1822. See Section 3 below for details. [^]
  7. The data series evidencing this stops in 1825, so is unclear to what degree this exchange continues after 1825. [^]
  8. The last time the price index had fallen this low in the past was July 1792, and the next time the price index would reach this level would be November 1849 (Gayer et al 1975, as reported in Hill et al. 2015). [^]
  9. Tooke attributes this solely to demand and supply effects in agricultural markets. [^]
  10. John Richards and William Ward were senior directors of the Bank in the 1820s, and Richards in his 1832 testimony is critical of the government’s decision (H.C. 1832: Q4958), while Ward indicates that the change rendered superfluous the Bank’s carefully accumulated supply of gold (H.C. 1832: Q1975). [^]
  11. Indeed, Tooke (1838, 102) makes this argument explicitly. [^]
  12. Loans against Bank stock were trivial (H.C. 1832 App. 6), and authorized purchases of Exchequer Bills did not take place (H.C. 1832 App. 65). [^]
  13. Clapham (1945, vol. 2, 84–85) observes that while this business generated regular income, it also tied up the Bank’s assets over a long period of time. Indeed 45 years later one mortgage was still on the books. Thus, it is unsurprising that this form of lending did not continue. [^]
  14. The proposal allows for a loan of up to £7 million. We find however that on June 1, 1825 after two payments have been made £4.5 million is still outstanding (H.C. 1832 App. 67), and can conclude that the loan was probably only about £6 million. [^]
  15. Note that the Bank’s Total Assets only increase by £1 million from February 1824 to February 1825, due to a decline in the gold stock of £5 million or 37%. Half of this decline (£2.6 million) takes place from 26 November to 26 January (H.C. 1832 App. 88). £1.56 million are withdrawn in coin from the Bank between 1 July 1824 and 1 November 1824. Of this £885,000 is by Rothschilds in July/August – which may have been anticipating the effects of the debt conversion (H.C. 1832 App. 77). [^]
  16. Tooke (1838, 178–9) also points to the conversion loan, as well the purchase of the “Deadweight annuities” as a monetary factor that the Bank of England should have sterilized in order to avoid the “extravagance of speculation” which took place. [^]
  17. Note that by combining Pressnell’s data for 1825 failures which is measured by harvest years from July 1825 to June 1826 (Pressnell 1956, 443, 536–38) with Gilbart’s data for 1826 failures, which appears to be calendar year data, some authors have arrived at a higher figure (e.g. Turner 2009, 113; Acheson et al. 2011, 521). Because of the likelihood of double-counting due to inconsistent year measures, as well as the complexities of determining what constitutes a failure in this period (see Pressnell 1956, 443–47), we choose to rely on a single data series and use Gilbart’s figures for 1825 and 1826. [^]
  18. For example, in the data reported by Acheson et al. (2011, 521) more than 30% of the English country bankruptcies from 1792 through 1826 take place in 1825 and 1826. [^]
  19. British Losses (1858) is sometimes cited as evidence of the significant losses incurred due to English bank failures, but the text itself acknowledges that its record of payments is incomplete. For example, Pole Thornton & Co is listed as a London bank that failed in 1825 and paid only 11s3d (or 56%) over the course of 8 years. This is clearly erroneous as other evidence makes it clear that Pole Thornton paid in full. Pole Thornton’s managing partner, Henry Sykes Thornton, had joined another bank Williams, Deacon, Labouchere, Thornton & Co as a partner by 1828, and as was noted above, the debt to the Bank of England had been paid by 1832. [^]
  20. The whole of the loan was paid back by 1832 when the Bank issued an order to reconvey the estates belonging to Messrs. Pole and Down, the principals of Pole Thornton & Co, to them (C.D. July 12, 1832). See also C.D. Oct 27 1831 on final payment by Peter Pole. [^]
  21. The decline after the 1825 crisis frequently took the form of amalgamation, a process which was facilitated by the authorization of joint-stock banking (Garnett et al. 2017, 817). [^]
  22. For example, on these two principles Thomas Tooke stated to the 1832 Committee: “I am not aware that the Bank should be considered as necessarily bound in the regulation of its issues to look to any thing but the amount of its treasure and the Exchanges” (H.C. 1832: Q3850). William Ward explained in some detail to the 1832 Committee how this second principle was adopted as a pragmatic necessity by the Bank directors (H.C. 1832: QQ2073–80). Ward also explained how Hume’s price specie flow mechanism, which states that prices adjust directly in response to specie flows as long as the Bank functions as a passive conduit converting bank liabilities into gold, in fact, acts only “eventually,” while “in the intermediate space great inconvenience arises” when the Bank permits the money supply to fluctuate (H.C. 1832: Q2108; see also QQ3614–15). [^]
  23. See for example July 1823 or January and July 1824 as documented in the 1832 Report, Appendix 83. [^]
  24. The specific questions that the 1832 Committee was empaneled to evaluate are (i) whether there should be multiple joint-stock banks of issue in London (ii) if the Bank of England is to be the sole bank of issue, are all of the Bank’s exclusive privileges necessary and (iii) what supervision should the Public have over banks of issue and in particular should they be required to periodically publish their accounts (1832 Report, 3). The committee does not reach any clear answers to these questions, but instead present the whole of the minutes of evidence to the public. It is clear throughout the report that questions have been raised about the Bank’s conduct in the months leading up to the 1825 crisis. [^]
  25. Given that the Bank and its management is explicitly being investigated by the Committee, it is unsurprising that the all of the Directors are very careful not to draw a clear connection between the Bank’s circulation of notes and the boom bust cycle. At least for the more astute directors such as Ward, it is probably best not to conclude on the basis of this testimony that this is something they do not understand. [^]
  26. Note, however, that Jeremiah Harman (1832 Report QQ2174–76, 2381), an elderly Bank director who had also testified on behalf of the Bank before the 1810 Bullion Committee, staunchly defended the position that there could be no connection between an increase in Bank notes and rising prices. [^]
  27. In fact, in his testimony to the 1832 Committee Burgess relies on the experience of the 1825 crisis to develop a theory of fiat money that could be regulated to avoid “expansions and contractions.” Furthermore, this testimony was published as a booklet in 1832 and is currently held in 126 different libraries worldwide (H.C. 1832 QQ 5339–5360). [^]

Competing Interests

The author has no competing interests to declare.

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