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Bank of England, Local Currency Scheme Websites, ONS and Bank Calculations Topical articles Banknotes, local currencies and central bank objectives 317 Banknotes, local currencies and central bank objectives By Mona Naqvi and James Southgate of the Bank’s Notes Division.(1) • A few towns and cities in the United Kingdom have set up local currency schemes to promote local sustainability. The schemes issue paper instruments with some similar design features to banknotes. This article explains how these instruments differ from banknotes. • The size, structure and backing arrangements of existing schemes mean that local currencies are unlikely to pose a risk to the Bank’s monetary and financial stability objectives. Nonetheless, consumers should be aware that local currency instruments do not benefit from the same level of consumer protection as banknotes. Overview The Bank of England’s issuance of banknotes feeds into its Summary table Features of local currency schemes that monetary stability objective, which includes maintaining mitigate potential risks to the Bank’s objectives confidence in the physical currency. This requires people to Objective of the Bank Potential risk to that Feature(s) of local currencies that be confident that the banknotes they hold will continue to objective can reduce that risk be widely accepted at face value. The promise by the Bank of Price stability Local currency schemes The schemes are small relative to lead to significant and aggregate spending in the England to make good the value of its banknotes for all time, unanticipated impacts on economy. aggregate economic as well as its use of robust security features and a activity. wide-ranging programme of education on how to identify Confidence in the Fears surrounding the Design features and marketing genuine banknotes, helps to ensure that this objective is met. physical currency authenticity of local material help users to recognise currency vouchers spill over that local currency paper to reduce confidence in instruments are like vouchers Banknotes are, however, just one form of payment banknotes. and not banknotes. instrument used alongside other physical media of exchange, Financial stability The failure of a local The schemes are small relative to currency scheme aggregate spending in the such as cheques or retail vouchers. A few UK towns and destabilises the financial economy and the one-for-one system as a whole. backing assets are securely cities have set up their own local currencies, issuing physical ring-fenced. instruments that are akin to vouchers, although some are designed to look similar to banknotes. Given that the schemes currently operating in the Local currency schemes aim to boost spending within the United Kingdom are at present small (both individually local community and, in particular, among locally owned and in aggregate) relative to aggregate spending in the businesses. In addition, there may be other grounds for economy, and are typically backed one-for-one with companies to participate, such as promotion in the scheme’s sterling, they are unlikely to present a risk to the Bank’s marketing material. Participation by both businesses and monetary or financial stability objectives. Nevertheless, a consumers might also reduce environmental footprints as risk could arise if consumers mistakenly associate local well as signal a commitment to supporting the local currencies with banknotes. Such a perception could generate community. a spillover effect if, for example, a successful counterfeit attack on a local currency were to reduce confidence in The Bank of England takes an interest in schemes that have banknotes or, in the event of failure, if consumers were to the potential to impact its monetary and financial stability incorrectly expect recompense from the Bank. Bearers of objectives. A number of mitigants exist which, if local currency vouchers do not benefit from the same level of implemented by current and future local currency schemes, consumer protection as banknotes issued by either the Bank should mean that they do not pose a material risk to the of England or the authorised commercial issuing banks in Bank’s objectives, as outlined in the summary table. Scotland and Northern Ireland. (1) The authors would like to thank Mark Baker for his help in producing this article. 318 Quarterly Bulletin 2013 Q4 Introduction The evolution of fiat money In its role as a medium of exchange and a store of value, The Bank of England started issuing banknotes shortly after its money can essentially be thought of as a claim (or ‘IOU’) from incorporation in 1694, and since 1921 has been the monopoly one person to another. Historically, societies tended to adopt issuer of banknotes in England and Wales. Today the note commodities such as gold and silver as the dominant means of issue function forms part of the Bank’s monetary stability transferring claims from person to person (as a medium of objective, which includes the aim of maintaining confidence in exchange) or from one point in time to a later date (as a store (2) the physical currency. of value). In the 16th century, goldsmiths began to accept gold and silver deposits, in return issuing receipts to acknowledge the debt. Before long, depositors found it easier The United Kingdom is in an almost unique position in that the to simply use the receipts themselves as a means of payment, government also permits certain commercial banks to issue as they effectively represented a claim on the commodities in banknotes. There are three such issuers in Scotland and four the custody of the goldsmiths. Consequently, the in Northern Ireland (S&NI). Legislation was introduced in enforcement of claims on the reserves became less and less 2009 to ensure that, in the event of a commercial bank frequent. Goldsmiths were then able to lend out a proportion becoming insolvent, S&NI noteholders would be able to of their deposits (and earn a profit by charging interest), given redeem their notes at face value. that depositors were unlikely to withdraw all of their coins at the same time.(3) In addition, there are many other physical media of exchange available for transactions. One example is retail vouchers, Throughout the 17th century, the British state borrowed from which have existed for many years but have a more restricted the goldsmiths to fund a series of wars with France. However, purpose and use than banknotes. More recently, ‘local the loans came with very high interest rates that led to currencies’ have been established in a few UK towns and cities. repeated defaults by the state. The Bank of England was These are in many ways an evolution of previous alternative established in 1694 to provide the state with a cheaper source currency experiments. Although the current UK schemes are of credit. Like the goldsmiths’ receipts, Bank of England notes small relative to the issuance of banknotes, the Bank takes an circulated as a means of exchange since they promised to pay interest in the development of local currencies that have the the bearer the sum of the note on demand. That is, anyone potential to impact its ability to meet its monetary and holding a banknote could, in principle, have it exchanged at financial stability objectives. the Bank of England for the designated value of gold. This article outlines the key differences between banknotes Over time, the number of banknote issuers declined. The Bank and local currency instruments. The first section reviews the Charter Act 1844 prohibited banks which did not already history of and rationale for central banks having a monopoly issue notes from starting to do so. It also prevented existing over banknote issuance. The second section explores the note-issuing banks in England and Wales (other than the Bank history of alternative currencies and the aims of UK schemes of England) from increasing the value of their note issue. The issuing physical instruments today. The third section Bank of England eventually became the monopoly note-issuer examines whether current local currency schemes pose a risk in England and Wales after the last private banknotes were to the Bank’s monetary and financial stability objectives. issued by the Somerset bank, Fox, Fowler and Co. in 1921. The Finally, the article considers user protection, and highlights authorised banks of Scotland and Ireland were, however, still that consumers have no recompense from the Bank of England permitted to issue banknotes.(4) in the event of a local currency scheme failure. A short video explains some of the key topics covered in this article.(1) Meanwhile, a period of financial upheaval in the late 18th century drained the Bank’s bullion reserves to the point Central bank money where it was forced to stop paying out gold for its notes until 1821, during what became known as the ‘Restriction Period’.(5) This section briefly reviews the origins and rationale behind The link to gold was broken again with the onset of the central bank money. To do this, it is useful to consider the First World War and briefly resurfaced in the form of the gold three key functions of money, which are to act as a: standard (fixing the value of sterling to gold) in the inter-war period. However, following further financial upheaval, the (i) Medium of exchange with which to make payments. (1) See www.youtube.com/watch?v=JrlSag_tkLo. (ii) Store of value with which to transfer ‘purchasing power’ (2) Such commodities were often used because of properties such as their divisibility, (the ability to buy goods and services) from today to some homogeneity and portability to facilitate the transfer of claims, rather than because of any strong desire to own the commodities themselves. future date. (3) See Ryan-Collins et al (2011). (iii)Unit of account with which to measure the value of any (4) See Byatt (1994).
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