Bagehot’s Lombard Street and Macroeconomic Stabilisation

Bagehot’s Lombard Street (1873) has been recognised as the classic statement of the role and necessity of a Lender of Last Resort in a fractional reserve system. This perception has concealed, however, the fundamental nature of the work, which developed a sophisticated model of the business cycle, as the basis for shifting the focus of monetary control from the high‐powered money base to control via the rate of interest. In the course of developing this model, Bagehot was able to show that using Bank Rate to protect the reserve in the Bank of England, in anticipation of the cycle of the market rate of interest, rather than simply following the market rate, would both enable the Bank to fulfil its role as Lender of Last Resort, and to stabilise the business cycle.