Money is created by the banking system issuing liabilities against itself. Under a fiat money system, nothing of intrinsic value backs the money supply. Viability of the system depends on shared faith. Central banks issue liabilities in the form of currency and deposits held by commercial banks in exchange for acquiring assets in the form of domestic government securities, foreign securities, or loans to commercial banks. These central bank liabilities constitute the monetary base. Commercial banks issue liabilities in the form of demand deposits held by the public in exchange for making loans. Commercial banks are constrained in money creation by the need to hold reserves with the central bank at a required ratio relative to demand deposits. The central bank must manage growth in the monetary base to maintain economic balance: too slow keeps the economy from performing at its potential while too fast causes inflation to rear up. To keep the economy on an even course, the monetarist school, led by Milton Friedman, advocates steady growth in the money supply. A pattern of inflation falling with slowing money growth shows up for Emerging East Asia between the 1990s and the 2000s.

The chapter analyses the three foundations of the new EU framework for macroeconomic governance, the European Macroeconomic Constitution. The provisions of the Maastricht Treaty stem from a rich background that informs about the content of the provisions and how they were assumed to lead to a successful monetary union. First, the economic constitutional thinking, originally by the German ordoliberal can be considered the philosophical foundation that informs how and why constitutional law addresses economic issues, particularly the monetary order. Second, longer evolution in central banking on one side and development in macroeconomic and monetary theory on the other side form the economic foundation. It informs about the assumption and content of various economic concepts and particularly about the 1990s broad consensus on central banking economics. Third, the institutional foundation is built on the institutional, legal and political development of the Community towards the establishment of the EMU. In the early 1990s, these three foundations happened to meet at the same intellectual crossroads that made EMU possible.

As the end of his MIT career approached, Kindleberger took on the challenge of explaining the catastrophic world depression that had been the context of his own intellectual formation. As against current Keynesian and monetarist orthodoxy, he wrote in defense of the conventional wisdom of his youth which, in his view, provided not only a viable explanation of events but even more a viable methodology for doing economics more generally. Comparative economic history would henceforth be his evangelical mission, explicitly so in his first postretirement book Manias, Panics, and Crashes, which became a best-seller.

This chapter discusses the currency union’s original set-up. It first discusses the history of European monetary integration, distinguishing between two sorts of motives: one economic, the other political. From the establishment of the European Economic Community up until the Treaty of Maastricht, both have been important drivers of monetary integration. The chapter subsequently turns to the original legal set-up of the euro, in particular its internal policy dimension. The economic and political forces behind the currency union’s creation also exercised great influence on its set-up, which came to institutionalise a stability paradigm. Characteristic of this paradigm was that it granted overriding importance to price stability as a policy goal and argued for a privileged position of the central bank in achieving this. The chapter shows how its influence was most notably evident at the level of aims and principles and in the constitutional position of the European Central Bank. Yet it also shaped the single currency’s economic foundations, in particular, the Union’s limited competences in this area and its focus on fiscal prudence. It even informed the rules governing accession.

This introductory chapter outlines the transformation or modernization of the Bank of England in the twenty years after 1979: how governance and accountability were transformed, and communication was accorded a greater role, as the Bank moved to policy autonomy or operational independence from the UK government. The process amounted to what might be described as an informational revolution. The transformation of macro-economic management may also be considered as part of a broader process of globalization. Central banks everywhere became much more aware of international activities and developments, and policy-makers reflected more on how the UK was affected by what went on beyond its frontiers. There was also a greater legalization: a need for legislation to define what was involved in banking, and how to regulate banking. Finally, the nature and definition of money and of monetary stability became the subject of a political debate.

After 1985, the UK first assigned a ‘greater importance‘ to exchange rate objectives, without specifying any rule; then followed between early 1987 and March 1988, an unannounced policy of linking the pound to the deutschemark at the rate of 3 DM/£ was pursued. That policy, undertaken without the knowledge of the Prime Minister, eventually led to a sharp political conflict between Thatcher and Lawson. Subsequently, the exchange target was abandoned. All three phases of the new exchange rate regime were conceptually incoherent, and the lack of monetary control in the second half of the 1980s eventually produced not only rapid growth (that looked like a policy success and was termed the ‘Lawson boom‘) but also a new upsurge of inflation that increasingly concerned the Bank. Eddie George emerged not only as a key architect of Bank strategy but also as a favoured interlocutor of Margaret Thatcher. A background to the policy debates was the increased attraction, to the Treasury and to some figures in the Bank, of the European Monetary System as a way of securing the deutschemark as an anchor, and international coordination on exchange rates became more central to monetary policy management; Thatcher and George were critical of that vision.

Monetarism was at the core of the ideological and policy wars of the 1980s, and of the strategy of the Conservative government headed by Margaret Thatcher. The UK had the highest rate of inflation in the industrialized world. By the 1970s, inflation was tearing the British social fabric apart: especially in its interactions with a government-imposed prices and wages policy. The British policy-making community could not agree whether money should be an overall objective of policy, or simply a target for an indicator that might be a temporary expression of how far the objective was being met, or an instrument for the conduct of policy in pursuit of the target. The Bank was initially quite sceptical about monetary targeting and hostile to monetarism. It believed that proposals for monetary base control ignored the structure of the British banking system, the knowledge of whose complexities and intricacies formed the core of the Bank of England’s professional competence. The keystone of the UK government’s approach was to target a range for £M3 growth as part of a Medium Term Financial Strategy. Meanwhile the Bank felt that it was shut out of policy formulation.

In practice, the early 1980s UK policy involved sporadically – but surprisingly often – responding to exchange rate movements, even when the exchange rate was specifically not designated as either a policy goal or an instrument, as well as raising interest rates as a way to cool down inflation but also economic growth. The 1981 budget, the most controversial of the Thatcher years, was accompanied by the attempt to take the pressure off manufacturing industry by lowering interest rates. The Bank responded to a surge in broad monetary aggregates by overfunding, that is, selling more than the amount of long-term debt (mainly gilts and National Savings instruments) required to finance the government. In 1983, a new Governor, Robin Leigh-Pemberton, who seemed more aligned with Thatcher’s view, came to the Bank of England, replacing Gordon Richardson, whose relationship with the Prime Minister had been strained. In the same year, a new Chancellor the Exchequer, Nigel Lawson, began a slow move away from monetarism and the application of monetary targets. The exchange rate came to play an increasing role in policy.

In 1976 UK economic policy making and fiscal strategy was transformed as a result of an exchange rate crisis that brought in the International Monetary Fund. Monetary targeting began to be a theme of policy debate. A central part of the pre-1979 influence and effective power of the Bank of England rested on the fact that the British domestic financial market was self-contained or cut off from the rest of the world, through the use of capital and exchange controls, applied to UK residents (corporations and individuals) but not to international holders of sterling. In 1976, as part of the IMF rescue package, exchange controls had been tightened, with a prohibition of use of sterling in trade financing that did not involve the UK. The incoming Conservative government started with a partial decontrol in July 1979, when restrictions on direct overseas investments were removed, and portfolio investment also became easier. In October 1979 exchange controls were completely abolished, a move which challenged the Bank of England’s control of the money supply.

This chapter explores cultural and literary representations of the ending of the gold standard, the so-called Nixon shock of the early 1970s. It focuses on the ways in which this move to floating exchange rates was represented through a nationalist, often militarised, language and argues that this discourse functioned as a paradoxical alibi for the increased ascendancy of private capital that was actually occurring in this moment. It explores the rhetorical move from crisis to discipline as it was simultaneously appearing in political, economic and popular literary genres of the early 1970s. The first two sections contrast the difference between a political and an economic use of the language of discipline, emphasising the ascendancy of a neoliberal definition of the ‘real’ of the money economy. The final two sections examine the ways in which genre writers deployed the twinning of a military and economic crisis to explore the ironies of this moment. It specifically focuses on the work of Don DeLillo and traces the shift in his own ironical sense of the efficacy of genre itself.

In the framework of a critical illustration of the contemporary history of economics, this chapter illustrates the various streams of neo-liberalism, from Ordoliberalism to Mises’s new Austrian school and Hicks’s Austrian capital theory, from Friedman and the Chicago school to rational expectations and supply-side economics, from the public choice school to political economics, from the Mount Pélerin Society to the Washington consensus and the idea of expansionary austerity. Step by step, the feeble theoretical and conceptual foundations of this set of theories are critically discussed.

In the framework of a critical illustration of the contemporary history of economics, this chapter presents a general picture of developments in monetary theory and in the theory of financial markets, beginning with the monetarist approach. The transition in the policy field from domination of the Keynesian to domination of the monetarist approach is then illustrated. The theory of efficient financial markets is then considered, from the Modigliani–Miller theorem to Fama’s contribution. A section is devoted to various issues in the theory of financial markets and institutions, as an introduction to Minsky’s ‘truly Keynesian’ analysis of financial markets and their fragility as the repeated origin of crises. Finally, Minsky's idea of a new stage in the development of capitalism, the so-called money managers capitalism, is recalled.