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«Drawing on monthly data for 12 European countries, this paper asks whether countries under the Classical Gold Standard followed the so-called ...»

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Monetary Policy under the Classical Gold Standard 1

(1870s - 1914)

Drawing on monthly data for 12 European countries, this paper asks whether countries

under the Classical Gold Standard followed the so-called “rules of the game” and, if so,

whether the external constraint implied by these rules was more binding for the periphery

than for the core. Our econometric focus is a probit estimation of the central bank

discount rate behaviour. Three main findings emerge: First, all countries followed specific rules but rules were different for core countries as opposed to peripheral countries. The discount rate decisions of core countries were motivated by keeping the exchange-rate within the gold points. In stark contrast, the discount rate decisions of peripheral countries reflected changes in the domestic cover ratio. The main reason for the different rules was the limited effectiveness of the discount rate tool for peripheral countries which resulted in more frequent gold point violations. Consequently, peripheral countries relied on high reserve levels and oriented their discount rate policy towards maintaining the reserve level. Second, there was a substantial amount of discretionary monetary policy left to all countries, even though we find that core countries enjoyed marginally more liberty in setting their discount rate than peripheral countries. Third, interest rate decisions were influenced more by Berlin than by London, suggesting that the European branch of the Classical Gold Standard was less London-centered than hitherto assumed.

JEL classification: E4, E5, E6, F3, N13 Keywords: gold standard, rules of the game, balance-of-payment adjustment, central banking Earlier versions of this paper were presented at the EHS, EHES and IEHA meetings as well as to seminars in Paris, Oxford, York and Glasgow. I am grateful to the participants for their spirited discussion and helpful suggestions. I owe a special thanks to the following people in helping me collect the data: Ivo Maes and Arnold de Schepper (National Bank of Belgium), Kath Begley (Bank of England), Alfredo Gigliobianco (Bank of Italy), Mrs Beex (De Nederlandsche Bank), all members of the data collection task force of the South-East European Monetary History Network, Erik Buyst, Jan Tore Kloveland, Larry Neal, Giuseppe Tattara, Anders Ogren and Marc Weidenmier. The usual disclaimer applies.


The Classical Gold Standard (1870s – 1914) has attracted the interest of economists, economic historians and policy-makers ever since its foundation. The exchange-rate stability among most countries of the world for some forty years was unprecedented and remained an inspiration for policy-makers after both world wars. At the time, adherence to gold was not entirely uncontroversial, as the international bimetallic movement of the mid-1870s to mid-1890s demonstrates. But the perspective soon changed as a result of monetary instability following World War I and high exchange-rate volatility in the 1930s; policy-makers came to idealize the pre-World War I gold standard as a benchmark against which any international monetary system should be measured – hence the label Classical Gold Standard.

Economists and economic historians, aware of costs and benefits of adhering to a system of fixed exchange-rates, have tended to avoid the eulogistic tone of policy-makers; they have contributed to the gold standard myth, however, by producing a highly stereotypical account of its working. Some of the stereotypes have surely been overturned by more recent research. Following Hume’s price-specie mechanism (1752), the textbook account of the gold standard had it that physical gold was shipped between countries to settle balance-of-payments disequilibria. Recent research, following earlier leads1, has demonstrated the importance and sophistication of foreign exchange policy.2 In other cases, recent research has provided the empirical basis to verify or reject some of the claims made in the older gold standard literature. This would be the case for the discussion on the benefits of gold standard adherence which are seen in improved access to global capital markets and reduced transaction costs with other gold standard countries.3 Yet another strand of the recent literature has highlighted conditions crucial to the workings of the Classical Lindert, Key Currencies.

Jobst, "Market Leader”.

Bordo and Rockoff, "Gold Standard”. Lόpez-Cόrdova and Meissner, "Exchange-Rate Regimes”.

Gold Standard which had been neglected so far, such as the importance of labour mobility and remittances in smoothing the adjustment mechanism.4 While the gold standard myth has given way to a broader empirical analysis in some debates, in other areas it stubbornly persists. One of them is the alleged core-periphery dichotomy.

It is argued that the adjustment process to balance-of-payments disequilibria was much smoother for the industrialised core countries of North-Western Europe as opposed to the peripheral economies. Different authors have emphasised different factors in explaining the alleged advantages of the core countries in the adjustment process. Drawing on the theory of optimum currency areas, one school of thought has argued that core countries were better suited for monetary integration.5 Others have argued that central banks6 of core countries helped each other in times of crisis, but did not help peripheral economies for the lack of self-interest.7 The more recent literature has emphasized differences in credibility8, whereas an older school of thought highlighted the peripheral countries’ role as debtors in the global financial system which made them vulnerable to sudden withdrawals of funds in times of financial strain.9 Arguing in favour of a pronounced core-periphery dichotomy not only seemed theoretically plausible, but it also appeared to provide a solution to a paradox which had emerged in the

empirical gold standard literature in the late 1950s and has, to this day, never been fully solved:

economic theory suggests that countries, faced with a gold outflow, had to raise the interest rate and/or reduce the monetary base to stop, or even reverse, the gold outflow. Keynes famously called this “playing by the rules of the game”. In the modern parlance of the macro-economic policy Esteves and Khoudour-Castéras, "Fantastic Rain of Gold”. Khoudour-Castéras, International Adjustment.

Martín Aceña and Reis, eds., Monetary Standards.

We will use the word “central bank” in the following, even though the transition to modern central banking had not yet been completed and the terminology “banks of note issue” would be more appropriate.

Eichengreen, "Central bank cooperation”. Flandreau, "Central Bank Cooperation”.

Hallwood, MacDonald, and Marsh, "Credibility”. Bordo and MacDonald, "Interest Rate Interactions”.

de Cecco, Money and Empire.

trilemma, we would describe this as the loss of monetary autonomy as a consequence of opting for fixed exchange-rates and free capital mobility.10 Whenever the “rules of the game” were put to a test, however, it turned out that countries actually had a very mixed record of following them. Bloomfield’s path-breaking 1959 study on 12 European countries under the Classical Gold Standard showed that more countries disregarded the rules than followed them.11 Subsequent studies focusing on England, France, and Germany also demonstrated that rich core countries could get away with frequent and sizeable violations of the “rules of the game”.12 This discrepancy between what economic theory suggests countries should do from what they actually did became known as the “gold standard paradox”.

This paradox remained unresolved until the 1990s, when economic historians began applying the theoretical insights of Krugman (1991) and Svensson (1994) to economic history.13 Krugman and Svensson had shown that monetary autonomy was not completely relinquished if countries commit to target zones (i.e. an upper- and a lower bound around central parity), as long as agents viewed the countries’ commitment as credible. The gold standard was now re-interpreted: it was no longer seen as a system of fixed exchange-rates (implying the complete loss of monetary autonomy, something seen as irreconcilable with the empirical literature on the rules of the game), but as a system of target zones the limits of which were determined by the gold points. It was followed from this that, as long as economic agents view a country’s commitment to gold as credible, such a country could violate the “rules of the game” in the short-run with a view to other policy goals.14 Solving the gold standard paradox this way might be tempting, but we have three fundamental objections. First, while the Krugman/Svensson target zone approach might give a Obstfeld, Shambaugh, and Taylor, "Trilemma”.

Bloomfield, Monetary Policy.

Dutton, "Bank of England". Pippenger, "Bank of England Operations”. Giovannini, "Rules of the Game”. Davutyan and Parke, "Operations of the Bank of England". Jeanne, "Monetary Policy”. Reis, "Art".

Krugman, "Target Zones”. Svensson, "Why Exchange Rate Bands?”.

Hallwood, MacDonald, and Marsh, "Credibility”. Bordo and MacDonald, "Interest Rate Interactions”.

theoretical explanation as to why core countries could violate the rules of the game while the periphery could not, it seems prudent to first establish that peripheral countries actually did follow the rules. The lack of comparative studies does not allow us to draw such a conclusion at this stage.

On the few occasions where a peripheral country was subjected to close examination, the opposite seemed to be true.15 Vice versa, in this paper we will present evidence that core countries occasionally did violate the gold points, suggesting that self-stabilising speculation did not always come to their rescue. Second, the notion of room for monetary manoeuvre under gold has not gone unchallenged. Coming from the perspective of the macro-economic policy trilemma, Obstfeld&Taylor&Shambaugh find that monetary autonomy was substantially reduced under the Classical Gold Standard.16 This is true both for core and for peripheral countries in their sample.

Third and most crucially, the entire discussion on the “rules of the game”, as it has emerged after Bloomfield’s path-breaking 1959 book, appears flawed. The post-Bloomfield research is united in its belief in a uniform set of rules for all countries under gold: rules were either followed or not, and the empirical evidence mustered suggests that they were normally not. This dichotomy completely neglects the possibility that different countries followed different rules. A careful reading shows that Bloomfield never said that gold standard countries did not follow the rules of the game. Rather, Bloomfield believed, as his concluding remarks show, that the rules were more complex and had not yet been discovered.

This paper sets out to follow Bloomfield’s lead. Drawing on a sample of 12 European countries (Austria-Hungary, Belgium, Bulgaria, England, France, Germany, Italy, the Netherlands, Norway, Romania, Serbia, Sweden) and relying on monthly data – the highest frequency we can aim for given the historical records -, we will analyse whether countries followed the so-called “rules of the game” and, if so, whether the external constraint implied by these rules was more binding for the periphery than for the core. In the process of collecting the data required for this analysis, it became clear to us why a comparative study of similar size and data frequency had never been conducted before: with the exception of England, Italy and Norway, the central banks have not Flandreau and Komlos, "Core or Periphery?”. ———, "Target Zones”.

Obstfeld, Shambaugh, and Taylor, "Trilemma”.

made their historical balance sheet data publicly available. Most of the data (though not all) could be found in the Annual Reports of the time, but copies of these reports can nowadays only be found in the archives of the respective central banks. Hence intensive collaboration with the historical archives of the central bank in question was needed to reconstruct the time series.

Following standard classification17, we will treat England, France and Germany as core countries and add to this group Belgium and the Netherlands because of their advanced economic status; throughout the Classical Gold Standard period the latter two countries enjoyed higher GDP per capita than either France or Germany. The other seven countries are viewed as periphery.

Three main points emerge from this paper: First, our econometric findings suggest that all 12 countries followed specific rules but rules were different for core and for periphery. The discount rate decisions of core countries were largely motivated by the exchange-rate behaviour towards England, France, and Germany; i.e., by the intent to keep the exchange-rate within the gold points.

This rationale played little role for peripheral countries, whose discount rate decisions were taken in response to changes in the domestic cover ratio. Core and periphery have in common a strong element of interest rate followership with respect to London and Berlin. We also explain why peripheral economies opted for rules different from those of the core countries. Second, our estimations suggest that there was a substantial amount of discretionary monetary policy left to all countries but core countries enjoyed marginally more liberty. In other words, our findings do challenge the conventional wisdom of a strong core-periphery dichotomy of the Classical Gold Standard. The third point this paper makes relates to interest rate leadership. Conventional wisdom has it that the Bank of England set interest rates and the rest followed.18 As indicated above, the interest rate decisions of all 12 countries were influenced by interest rates set in London and Berlin but, on balance, the interest rate leadership of the Reichsbank was stronger than of the Bank of England. This finding suggests that the European branch of the Classical Gold Standard was less London-centered than hitherto assumed and that Berlin played an important role in the European money market.

Eichengreen, Golden Fetters, pp. 5, 30.

Eichengreen, "Conducting”. Tullio and Walters, "Was London the Conductor”.

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