Evaluation of the relevance of Walter Bagehot’s ‘Lombard Street: A Description of the Money
Market” in modern banking system
In the chapter “A General view of Lombard Street” of his book “Lombard Street: A
Description of the Money Market” (1873), Walter Bagehot explains risks that a Central Bank may
face and how these risks can be avoided in different periods of the economic cycle, especially during
crisis. As the work has been written over a hundred years ago, some of the issues he raised has already
been solved, while others still are current. Therefore, explained concepts are important to the
economy and business students, as the crises happen, and the present banking system has not proved
itself to be perfect yet. In this essay I will evaluate the relevance of Bagehot’s statements in modern
economic and banking system.
According to Bagehot, it is important for the government to finance a central bank to meet
foreign and domestic demands, especially during crises. He mentions some risks concerned with
central banking. One of them is a principal agent problem, which is when the bank’s management acts
out of personal interests, and not the bank’s interests. Managers’ (who Bagehot also addressed as
‘amateurs’) that are acting out of their wrong incentives may eventually harm the bank, or even cause
a bank run. Managing a bank run is, however, rather a mercantile problem than a banking problem. As
soon as people are uncertain about their future, they will be willing to withdraw their money, leading
to panic and, in the end, a bankruptcy that could have been avoided if the panic never occurred.
Market” in modern banking system
In the chapter “A General view of Lombard Street” of his book “Lombard Street: A
Description of the Money Market” (1873), Walter Bagehot explains risks that a Central Bank may
face and how these risks can be avoided in different periods of the economic cycle, especially during
crisis. As the work has been written over a hundred years ago, some of the issues he raised has already
been solved, while others still are current. Therefore, explained concepts are important to the
economy and business students, as the crises happen, and the present banking system has not proved
itself to be perfect yet. In this essay I will evaluate the relevance of Bagehot’s statements in modern
economic and banking system.
According to Bagehot, it is important for the government to finance a central bank to meet
foreign and domestic demands, especially during crises. He mentions some risks concerned with
central banking. One of them is a principal agent problem, which is when the bank’s management acts
out of personal interests, and not the bank’s interests. Managers’ (who Bagehot also addressed as
‘amateurs’) that are acting out of their wrong incentives may eventually harm the bank, or even cause
a bank run. Managing a bank run is, however, rather a mercantile problem than a banking problem. As
soon as people are uncertain about their future, they will be willing to withdraw their money, leading
to panic and, in the end, a bankruptcy that could have been avoided if the panic never occurred.
