Two centuries of policy in

This paper is devoted to currency policies in Austria over the last 200 years, attempting to Heinz Handler1 sketch historical developments and uncover regularities and interconnections with macroeco- nomic variables. While during the 19th century the exchange rate resembled a kind of ­technical relation, since World War I (WW I) it has evolved as a policy instrument with the main objec- tives of controlling inflation and fostering productivity. During most of the 200-year period, Austrian were subject to fixed exchange rates, in the form of silver and gold ­standards in the 19th century, as a gold-exchange standard and hard currency policy in much of the 20th century, and with the as the single currency in the early 21st century. Given Austria’s euro area membership, national exchange rate policy has been relinquished in favor of a common currency which itself is floating vis-à-vis third currencies. Austria’s predilection for keeping exchange rates stable is due not least to the country’s transformation from one of Europe’s few great powers (up to WW I) to a small open economy closely tied to the large German economy. JEL classification: E58, F31, N13, N14, N23, N24 Keywords: currency history, exchange rate policy, , Austria

When the privilegirte oesterreichische versus flexible exchange rates. During National-Bank­ (now Oesterreichische most of the period considered here, Nationalbank – OeNB)2 was chartered Austrian currencies were subject to in 1816, the currency systems of major fixed exchange rates, in the form of sil- nations were not standardized by any ver and gold standards in the 19th cen- formal agreement, although in practice tury, as a gold-exchange standard in a sort of specie standard prevailed. much of the 20th century and with the Functioning bullion markets and the euro as the single currency in the early absence of capital restrictions produced 21st century. In between, brief phases of roughly constant bilateral exchange exchange rate flexibility prevailed (e.g. rates of participating gold or silver cur- following the end of the Bretton Woods rencies. With the introduction of paper system), but before long they would money and the practice of coinage give way to another peg system, includ- ­debasement, financial breakdowns often ing Austria’s renowned hard currency mirrored the abuse of the currency sys- policy and, later, euro area membership. tem for government financing purposes. Section 1 briefly reviews the possible Measurable changes in currency prices role of the exchange rate as an eco- were overwhelmingly the result of wars nomic policy instrument. The subse- and revolutions and their impact on quent two sections, which rely heavily government finance and inflation. on Jobst and Kernbauer (2016) and Repeated crises, which were already Butschek (1985), are devoted to the occurring during the ­development of currency relations in ­period of the late 19th and early 20th Austria and their linkages to the rest of century and which were aggravated by the economy: Section 2 deals with the the experience of the unstable interwar era before World War I (WW I) and period, sparked the discussion on fixed section 3 with exchange rate policies

1 University of Technology, Institute of Statistics and Mathematical Methods in Economics and Emeritus Consultant, Austrian Institute of Economic Research (WIFO), [email protected]. The author would like to thank Ernest Gnan, Maria Teresa Valderrama (both OeNB) and the referee for helpful comments and valuable Refereed by: suggestions. Of course, responsibility for remaining flaws lies with the author. Niels Thygesen, 2 In this contribution, “OeNB” will be used as an abbreviation for the various names the OeNB had in the course of University of its 200-year history, including the Austro-Hungarian Bank. Copenhagen

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and their effects after WW I and up to An early form of currency policy the present day. Section 4 examines occurred when paper money and coin- the interaction of exchange rates and age debasement eroded the value of a other economic policy variables such as currency, with the effect that the in- inflation, fiscal balances and external trinsic value of a coin or ­accounts. Section 5 summarizes. Why sagged below its face value. When a choose WW I as the dividing line be- currency’s link to specie gets lost, the tween sections 2 and 3? This is because currency’s credibility must be fur- in the earlier period, exchange rate nished by the economic fundamentals policy was confined to managing cur- and credible economic policies of the rency relations around essentially fixed issuing country, or at least by binding parities, whereas thereafter it has been legal restrictions on its asset holdings. utilized as an active element in steering Currencies then become national enti- the macroeconomy. Also, before WW I ties, and the exchange rate a measure of the dominating policy goal was to the relative economic strength of two ­balance the external accounts, while nations. With the varying importance thereafter internal targets such as eco- of specie coins, paper money and nomic growth and full employment ­foreign exchange, various monetary came to the forefront. ­regimes have evolved: • bimetallism in the early 19th century; 1 The exchange rate as a policy • the classical gold standard in the late tool 19th and early 20th centuries; Exchange rate policy in the modern • a variety of fixed and floating ex- sense gained importance only after the change rate regimes in the turbulent decline of the classical gold standard interwar period; during WW I. In previous times, vari- • the of gold- ous precious metals had been used as based fixed but adjustable exchange currencies, often regardless of national rates; and borders. The prices of silver and gold • generalized floating thereafter, which were formed on the world market and, also comprises the era of regional together with the gold and silver con- monetary integration in Europe. tent of a regional coin, they defined the These periods may also be differenti- price of that coin in terms of another ated by their regime of capital restric- region’s coin. Such relative prices were tions: Free capital movements had a independent of considerations concern- limited, though growing, influence ing the economic position of the re- during bimetallism and the gold stan- spective region. In fact, the metal stan- dard and have been a typical character- dard acted as an external anchor for the istic of the post-Bretton Woods man- currency. Currency prices represented aged floating system, while capital con- technical relations; they were not (yet) trols prevailed during the interwar utilized as policy instruments. Public period and in the early years of the authorities were involved, though, when Bretton Woods system. a currency’s parity was determined, Under the heading “exchange rate i.e. the number of face-value coins to policy,” two theoretical strands may be minted from, say, a pound of silver, be investigated: (1) determinants of or later on the number of ­silver ounces ­exchange rate changes (the flexible ex- to be exchanged for a unit of paper change rate as endogenous variable); (2) currency.­ expected consequences of steering the

62 OESTERREICHISCHE NATIONALBANK Two centuries of currency policy in Austria

exchange rate for the rest of the econ- dynamics and the eventual impact omy (the exchange rate as exogenous on domestic inflation depending on variable). the pass-through effect. A dominant When investigating exchange rate objective of pegging the exchange determination in the long run (short- rate to a stable anchor – be it a pre- run variations are not the focus of the cious metal or a foreign currency – is current paper), major textbook expla- thus to control price developments. nations, which are not mutually exclu- During the silver and gold standard sive, are: periods, the aim was to preserve • The purchasing power parity (PPP) credibility and the value of the cur- theory, which asserts that, in the ab- rency. In the case of Austria’s hard sence of market distortions, the currency policy, the goal was to sup- (floating) nominal exchange rate be- press cost increases and thereby also tween two currencies reflects the induce advances in productivity. relative price levels (of traded goods) • Via the terms-of-trade effect, a cur- in the two countries in question; for rency depreciation is perceived to changes over time it means that a contain or reduce a deficit in the cur- country with comparatively high in- rent account, with price elasticities flation would experience a depreciat- of import and export demand deter- ing currency. mining the dynamics (J-curve effect) • Relative prices are often just mirror- and final result (Marshall-Lerner ing the underlying monetary condi- condition). Textbook theory also tions, with the implication that under considers the effects of this result on a floating regime excessive money domestic spending behavior and supply will fuel inflation and gener- ­capacity constraints (absorption ap- ate a currency depreciation. If long- proach) as well as monetary condi- term capital transactions are also con- tions. sidered (portfolio balance approach In practice, exchange rates have at dif- to exchange rate determination), a ferent times been used as a policy tool relative decrease in domestic long- for different purposes. Dominant goals term interest rates will entail capital of steering nominal exchange rates have outflows and currency depreciation. been to dampen exchange rate variabil- • With regard to the real sector of the ity and to diminish price increases, as economy, structural differences be- was the case during Austria’s hard tween two countries may comple- ­currency policy period. Real exchange ment the price effects and determine rates can only be targeted indirectly the development of real exchange through nominal exchange rates and rates. Relative increases in home pro- price developments. Real depreciation ductivity or shifts in consumer pref- would contribute to improving com- erences from foreign to domestic petitiveness and thereby reduce a defi- goods would thus tend to appreciate cit in the current account. In the short the real exchange rate. run, changes in exchange rates have of- Turning the relation on its head, what ten been used as shock absorbers to are major long-run channels of ex- mitigate the impact of external shocks change rate changes to the rest of the on the real sector of the economy. This economy? function requires that changes in nomi- • A change in the exchange rate imme- nal exchange rates eventually show up diately alters the terms of trade, the as changes in the real exchange rates.

MONETARY POLICY & THE ECONOMY Q3– Q4/16 63 Two centuries of currency policy in Austria

With respect to empirical realiza- had climbed to some 500% by 1811. tions, the theoretical hypotheses sug- Eventually, national bankruptcy was gest that in the long run one-way rela- declared in 1811 and a currency reform tionships are rare, and one will rather initiated. Bancozettel were devalued by observe a co-movement of exchange 80% and had to be converted into rates and other economic variables. ­Wiener Währung, a new government However, the relationships mentioned ­paper money. Although the amount of here are setting the stage for the fol- Wiener Währung in circulation was lowing historical overview and for the ­restricted, the reform was jeopardized empirical investigation in section 4. by another new paper currency, the “Antizipationsscheine,” which were issued 2 Currency relations prior to from 1813 to anticipate the expected WW I revenues from a new land tax. In effect, The transition to the 19th century is too many Antizipationsscheine were characterized by a gradual formation of put in circulation without prior com- national currencies, linked together by munication to the general public, international prices of precious metals thereby eroding confidence in the ex- and liberal financial markets. Still mir- pected results of the currency reform. roring to some extent mercantilist ideas, To restore convertibility of Wiener economic policy at this time was largely Währung into Conventionsmünze, in 1816 oriented toward keeping the balance of the newly-founded OeNB was endowed payments in order. The prevailing spe- with a monopoly for printing cie standards secured constant bilateral and with a certain degree of indepen- exchange rates, as price fluctuations dence from the state administration, in the bullion markets did not alter ­although state financing was not ex- the relative currency values. Exchange plicitly prohibited. As stated by Jobst rates did thus not play a significant role and Kernbauer (2016: 52), “retiring as a policy tool. It was only the erratic, government paper money and replacing though gradually increasing, emission it with banknotes convertible into silver of paper money as an easy means of war was the primary objective of the authors and budget financing that provided a of the decree of 1816.” link to politics via inflation. Exchange The currency reform took many rate policy was confined to keeping years and was barely completed when fluctuations in currency prices low. the revolution of 1848 swept over to Austria. The banking system collapsed, 2.1 Early 19th century: War financ- and the OeNB covertly stepped in to ing, paper money and national ­finance the government by printing bankruptcy new money. When this was made pub- During the Napoleonic wars and the lic, a run on silver coins again ended subsequent war reparations, the origi- convertibility, initiating a law which nal redeemability of Austrian paper declared paper money as legal tender. money (Bancozettel) in silver coins The printing press was repeatedly acti- ­(florin Conventionsmünzen) was re- vated, as the Habsburg empire aspired voked. Between 1804 and 1808, the to be counted among the big European circulation of paper money multiplied players. However, neither the Austrian and massive inflation occurred. The economy nor the military machinery small silver premium against Banco­ would support such ambitions. As a re- zettel widened rapidly after 1806 and sult, the silver premium of the florin

64 OESTERREICHISCHE NATIONALBANK Two centuries of currency policy in Austria

fluctuated widely, peaking at some silver coins. As a consequence, the cen- 50% in the course of the year 1860. tral bank was swamped with silver ­ingots for coining, which induced the 2.2 From silver to gold decision to terminate the specie cover- The florin Conventionsmünze (fl. CM) re- age of currency altogether. In the years mained in circulation until 1857, when to follow, until the first half of the the Habsburg monarchy joined forces 1890s, the florin was maintained as a with the “Deutscher Zollverein” (Ger- paper currency, which is considered an man Customs Union) to reduce cur- early appearance of a flexible exchange rency diversity­ by adopting the “Vere- rate (Flandreau and Komlos, 2001; instaler,” a standard silver coin to be Chaloupek, 2003). used as a common currency based on When the Austro-Hungarian dual the rules of a full silver standard. The monarchy was established in 1867, a changeover to the new “öster­reichische switchover from silver to the gold stan- Währung” (ö.W.) resulted in a minor dard was discussed. gold coins devaluation (fl.1 CM = fl.1.05 ö.W.). had already been minted since 1857 The florin ö.W. remained legal tender and used mostly in cross-country pay- until 1901. ments, and in 1862 the OeNB had been To underpin the currency reform, a authorized to invest in gold as a basis transition from fiscal dominance (fi- for money in circulation. However, it nancing the state) to monetary domi- was not until 1892 that the dual monar- nance (monitoring the interest rate) chy changed from a silver parity to a was initiated by the “Plenersche Bank­ gold parity: 1 florin (100 kreuzer) of akte” or Bank Act (Jobst and Kern- the old silver currency was set equal to bauer, 2016). The Bank Act, effective 2 crowns (à 100 heller) of the new gold- from the beginning of 1863, strength- based currency. Although gold convert- ened the OeNB’s independence, rede- ibility was never fully implemented, fined the coverage of banknotes by the Austro-Hungarian Bank intervened ­either discount operations (for up to fl. in the foreign exchange market to stabi- 200 million) or silver (for the rest of lize the crown’s exchange rate against the banknotes in circulation), and set a gold standard currencies. As of 1896, tight timetable for the reduction of gov- this moved Austria-Hungary de facto ernment debt. to a gold-exchange standard (Yeager, Following the war defeat of 1866 1998). Flandreau and Komlos (2001) against Prussia, Austria again slipped consider the period from 1896 to 1914 into huge budget deficits, an increasing a successful early experiment in creat- tax ratio and an expansion of the money ing an exchange rate target zone with a supply. Speculative financial market credible parity and narrow, though not ­activities around the world fair in prespecified, margins. From 1910 on- ­Vienna eventually led to the collapse of ward, the OeNB was obliged, as an an- the stock market in 1873. The rapid ti-inflation device, to maintain a stable dissemination of the classical gold stan- exchange rate of the crown vis-à-vis dard caused the market price of silver other major currencies. With hind- to tumble so much that by 1879 a sight, this period resembles Austria’s ­discount situation emerged, i.e. paper hard currency policy of the late 20th money became more expensive than century.

MONETARY POLICY & THE ECONOMY Q3– Q4/16 65 Two centuries of currency policy in Austria

3 Exchange rate policies after hyperinflation. The value of the paper WW I crown collapsed. A turnaround was At the end of WW I, the monetary brought about in October 1922 when, ­regime of the Austro-Hungarian mon- under the auspices of the League of archy collapsed, and economic policy ­Nations, the “Geneva Protocol” was had to be oriented toward new objec- signed, committing Austria to remain tives. External equilibrium consider- an independent state, to prepare for the ations retreated into the background, issuance of international bonds (the while stabilizing the internal economy “Völkerbundanleihe”) on the basis of by reducing public debt and inflation the old gold crown of 1914, and to and restoring production capacities commence a major institutional reform ­became top priorities. With the end of including a stop on government financ- the classical gold standard, the exchange ing via the central bank. The reform rate was also discovered as an economic program immediately stabilized the in- policy instrument, and countries began flation rate as well as the exchange rate. to experiment with a return to some It included the emergence in 1923 of form of gold standard on the one hand, the OeNB out of the former Aus- and with flexible exchange rates on the tro-Hungarian Bank, and a changeover, other. The value of a currency would as of March 1925, from the crown to no longer necessarily be linked to the the Austrian schilling (10,000 crowns amount of specie in the vaults of the = 1 Austrian schilling), which remained central banks, but more and more to pegged to gold (at 0.21172086 grams of the economic fundamentals of an econ- fine gold to 1 schilling). However, omy, such as internal and external sta- Austria did not formally join other bility and total factor productivity. countries (e.g. the U.S.A., the United Kingdom, and ) in reviving 3.1 Interwar consolidation period: the prewar gold standard, but instead from soft to hard currency pursued an independent peg to gold, During WW I, financing for the ex- backed by foreign exchange controls. A ploding government expenditures of major task for the OeNB was to secure the Austro-Hungarian monarchy was a stable value for the currency com- largely acquired through war bonds. pared with other enduring currencies The resulting massive increase in the with the eventual aim of returning to money supply pushed up inflation and some variety of the gold standard (Jobst caused the exchange rate of the crown and Kernbauer, 2016). to depreciate. At the end of the war, The international turbulence on the Austro-Hungarian Bank attempted stock exchanges did not become mani- to maintain a common currency with fest in Austria until May 1931, when the other successor states of the former Creditanstalt went bankrupt. The dis- monarchy, but failed when Yugoslavia closure by Creditanstalt of heavy losses and Czechoslovakia started to stamp in 1930 triggered a bank run which their own banknotes. To avoid an un- could only be managed by massive controlled influx of unstamped paper ­liquidity assistance from the OeNB and crowns, Austria, in now starkly re- a government guarantee for all Credit­ duced territorial confines, had to fol- anstalt deposits. Inflation expectations low suit. The war-ridden economy con- increased, capital flight ­began, and the tinued to face enormous budget deficits OeNB lost almost all of its foreign and inflation which in 1921 turned into ­exchange. While the OeNB maintained

66 OESTERREICHISCHE NATIONALBANK Two centuries of currency policy in Austria

the gold parity of the schilling, the re- was terminated in 1936 (Kernbauer, introduction of foreign exchange con- 1991, Klausinger, 2006). trols3 in October 1931 sparked a gold In March 1938 Austria was occu- premium which had surged to some pied and integrated into the Third 28% at the end of 1931 and 33% by ­Reich. In a first step the German June 1932. The OeNB raised the dis- ­ was introduced as the new count rate step by step to 10% in early currency, and the schilling was ex- 1932. A full return to gold parity would changed at the rate of 1.5 schillings per have required massive price and cost reichsmark (revalued from previously reductions, which seemed out of reach 2.17 schillings per reichsmark). The (Kernbauer, 1991). Eventually, as ma- functions of the OeNB as a central bank jor countries abandoned the gold stan- were suspended and its gold reserves dard (starting with the United Kingdom transferred to the German Reichsbank. in September 1931), the schilling was The schilling/reichsmark relation has devalued against gold by 22% in July later been gauged appropriate with re- 1932 (März, 1990). spect to relative wages (Butschek, 1985) Irrespective of this rather short and relative prices (Kernbauer, 1991). phase of a weak exchange rate, the lon- ger-term performance of the schilling 3.2 From a war-ridden economy to was quite remarkable and yielded it the the Bretton Woods system nickname “Alpendollar” (Alpine dol- During World War II (WW II), when lar). This was underpinned by continu- the Bretton Woods system was negoti- ing foreign exchange controls (in effect ated, there was an overwhelming feel- until 1935) and by rather moderate ing among participants that economic budget deficits. The shrinking money stability could only be restored via supply (M1 contracted from 4.0 billion some sort of gold-exchange standard. schillings in 1928 to 2.2 billion schil- In effect, participants designed a sys- lings in 1934) was largely due to the tem with fixed but adjustable exchange ­reluctance of commercial banks to ex- rates and capital controls, though with tend credit to the private sector. The a commitment to gradually render cur- OeNB perceived its monetary policy as rencies convertible for current account not restrictive, as the monetary base in- transactions, while “corner solutions” creased slightly and the discount rate (rigid fixing or freely floating rates) could be lowered again. When in 1936 were rejected. a number of countries (among them Austria needed almost a decade to members of the ailing “gold bloc,” overcome postwar inflation and fiscal France, Italy and ) devalued imbalances, and to restore trade links their currencies, Austria, in an attempt and convertibility of the schilling as to counter inflation expectations, ab- preconditions for joining the gold-based stained from a comparable measure and Bretton Woods system. Immediately focused instead on accompanying de- after WW II, the exchange rate of the flationary measures. Thanks to the per- schilling was arbitrarily set by the ceived stability of the schilling, financial ­occupation forces to an overvalued supervision by the League of Nations 10 schillings per U.S. dollar, and for-

3 The spreading banking crisis had led to the introduction of foreign exchange controls in Germany as early as in July 1931.

MONETARY POLICY & THE ECONOMY Q3– Q4/16 67 Two centuries of currency policy in Austria

eign exchange transactions for exports subsidies and an increase in prices. The and imports had to be authorized. In reform was not completed until May parallel, “grey” market notations re- 1953, when the schilling was effectively sulted de facto in an undervaluation of devalued by establishing a unitary ex- the schilling which, however, was grad- change rate at the level of the premium ually eaten up by swelling inflation. rate. In a parallel development, Austria Exporters switched to compensation gradually relinquished the restrictive contracts and premium contracts, postwar foreign trade regime by gradu- thereby engendering a system of multi- ally following the liberalization efforts ple exchange rates. of the General Agreement on Tariffs Among the immediate efforts to and Trade (GATT) and the Organiza- stabilize the war-ridden economy were tion for European Economic Co-opera- a series of currency-related laws restor- tion (OEEC). In 1953 trade in goods ing the functions of the OeNB as of and services was liberalized, and this 1922, reducing money in circulation by move was trailed by a stepwise liberal- 60% and limiting the usage of the other ization of cross-country financial flows. 40% to purchases of vital goods only – The schilling only became convertible thereby also preparing for the change- for foreigners in 1959, with full con- over from the reichsmark to the schil- vertibility being achieved in 1962. ling. In spite of these measures, infla- When in 1955 the Federal Act tion surged from 26% in 1946 to 96% on the Oesterreichische Nationalbank in 1947. To achieve stabilization, a first (Nationalbankgesetz) was amended, wage and price agreement was negoti- the main objective of the OeNB’s schil- ated between the social partners in July ling policy was changed from introduc- 1947 (four more were to follow by ing a gold standard to preserving inter- 1951). In November 1947, as a precon- nal purchasing power and maintaining dition for access to the European external value in terms of stable foreign ­Recovery Program, a further reduction currencies. At the same time, the of money in circulation was accom- OeNB’s independence was strength- plished (exchanging 3 “old” schillings ened and its operational spectrum for 1 “new” schilling), which caused the ­enlarged to include open market opera- market premium over the “official” tions and minimum reserve require- schilling exchange rate to dwindle ments. rapidly.­ Inflation in the late 1950s and early In August 1948, Austria became a 1960s was moderate and not as high as member of the Bretton Woods institu- in other partner countries. As the real tions by pledging to ease foreign ex- economy flourished and the current change restrictions and abandon the ­account developed favorably, the parity dual exchange rate system. In Novem- of 26 schillings per U.S. dollar was ber 1949, the foreign exchange system never endangered until the gold con- was simplified with the effect that, in vertibility of the U.S. dollar ended in addition to the devaluation of the “offi- August 1971. cial” exchange rate (now at the “basic rate” of 14.40 schillings per U.S. dol- 3.3 Stepwise approach to a hard lar), a “premium rate” of 26 schillings ­currency policy per U.S. dollar (close to the market The collapse of the Bretton Woods sys- rate) was established. For many trans- tem turned out to be an extended and actions this was tantamount to a loss of painful experience, lasting from the

68 OESTERREICHISCHE NATIONALBANK Two centuries of currency policy in Austria

end of U.S. dollar convertibility (August The first oil price crisis and the in- 1971) to the approval of generalized ternational recession of 1975 showed floating (March 1973). Although flexi- up in the large current account deficits ble exchange rates relieved many coun- of 1976/77. As a remedy, fiscal policy tries from balance of payments strains, turned restrictive and the OeNB this period is also characterized by high changed its focus to stabilizing the de- exchange rate variability. To make up preciation of the real effective exchange for the loss of gold as an anchor, central rate (REER), an endeavor in which it bank independence was emphasized was aided in any case by the deteriorat- and inflation targeting ­adopted as a new ing exchange rate of the U.S. dollar. In state of the art for a stability-oriented nominal terms, the OeNB attempted monetary policy strategy. In the Euro- to secure the credibility of the schilling pean Union (EU) this revived the dor- by reducing the variability of the schil- mant project to ­create, at least for a ling/ relationship which, large number of Member States, the from mid-1981, was practically nil. euro area as a ­regional fixed exchange ­Afterward, when divergences in the rate bloc. The international financial economic development of Austria and crisis of 2008, and in its wake the euro Germany surfaced, exchange rate sta- area sovereign debt crisis, have once bility was bought via an interest rate again called into question the meaning- premium in Austria over Germany. fulness of fixed exchange rates for In the EU, the 1990s were largely countries with strongly diverging eco- devoted to achieving the preconditions nomic fundamentals. for taking part in the stepwise process To contain the drawbacks of float- of Economic and Monetary Union ing exchange rates in general, and to al- (EMU), among other things by com- leviate price increases in particular, pleting the liberalization of interna- Austria was among the first countries tional capital transactions (Nauschnigg, to adopt a “hard currency policy” 2003). The credibility of a stable ex- (Handler, 1989, 2007). Already in May change rate was thereby upheld and 1971, the monetary authorities had was tested only once, when in ­August swung from balancing the current ac- 1993 a speculative attack on the schil- count to dampening inflationary pres- ling was countered by the OeNB with- sures through revaluing the schilling by out major strain. Overall, the hard cur- some 5%. Anti-inflationary arguments rency policy helped Austria to achieve were also advanced when (1) the OeNB and maintain price stability without ob- invented a composite currency Indica- vious negative side effects on economic tor to define the benchmark for the growth and employment. schilling exchange rate in August 1971; (2) the schilling was leaning toward the 3.4 Smooth transition to the single European “snake” currencies in an European currency ­attempt to reduce exchange rate vola- At the beginning of 1995 Austria joined tility within the “tunnel” of the Smith- the EU, aspiring to participate in all sonian Agreement from April 1972; steps toward completing EMU. Adopt- and (3) the Deutsche mark replaced the ing the euro from its start in 1999 snake currencies as the guideline for meant that Austria would relinquish the schilling exchange rate from July the schilling in favor of becoming a 1976 (Schmitz, 2016). member of a large currency union com- prising its most important trading part-

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ners. The single currency is equivalent 4 Interactions between exchange to an irrevocably fixed exchange rate rates and other policy variables and implies that balance of payments Subject to the availability of reliable strains now have to be borne via adjust- historical data, this section provides an ments in the internal economy. overview of 200 years of exchange rate The euro has become one of the development in Austria in relation to dominating currencies in international the development of prices, fiscal bal- financial markets with flexible ex- ances and public debt as well as mone- change rates vis-à-vis other currencies. tary and real sector variables. The euro’s exchange rate developments have been a function of the interna- 4.1 Long-term effective appreciation tional relations between major eco- in nominal and real terms nomic areas, most importantly between To capture the whole exchange rate Europe and the U.S.A. Since 1999, spectrum of a country’s trade relations, large exchange rate swings have oc- effective (trade-weighted) nominal and curred, with the euro appreciating by real exchange rates (NEER and REER) some 85% from June 2001 to July would have to be considered. An appre- 2008, and thereafter depreciating by ciation of the REER (i.e. a loss in some 32% up to November 2015. ­relative competitiveness) results from Exchange rate policy in the euro either an appreciation of the NEER or a area is a shared competency of the relative increase in domestic prices. As ­ and the EU Council. The chart 1 reveals, since the end of the former handles the daily interventions Bretton Woods system and up to the on foreign exchange markets while the mid-1990s the schilling significantly latter is responsible for the general appreciated in nominal terms (more ­orientation of the exchange rate system than 100%) as well as in real terms after consulting the European Central (some 30%), reflecting predominantly Bank (ECB). The OeNB is a member of Austria’s hard currency policy with its the Eurosystem and has a seat on the explicit aim of wage and price modera- Governing Council of the ECB. tion and productivity gains. In the mid-

Chart 1 Nominal and real effective exchange rates for Austria from 1960 to 2015 Index 1960=100 220

200

180

160

140

120

100

80 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 NEER REER (labor cost-adjusted)

Source: AMECO.

70 OESTERREICHISCHE NATIONALBANK Two centuries of currency policy in Austria

1990s this general trend came to an flation per se. Over the long period end when, in the run-up to the com- considered here, nonwar periods have mon currency, budget deficits were been characterized by broadly parallel ­reduced and the relative labor cost po- developments of moderate inflation and sition improved. Overall, the much reasonably stable exchange rates, while faster nominal appreciation indicates marked interruptions occurred during that deteriorating price competitive- wars (Napoleonic wars, 1866 Prussian ness stemming from the increase in the War, WW I, WW II) and in the con- NEER was partly compensated by a de- text of currency reforms. While until crease in relative costs and prices. Since the end of WW II inflationary periods the turn of the century, NEER and were often succeeded by , in REER movements have been closely the era since no protracted deflation correlated, which means that internal has occurred in Austria (table 1). and international prices have developed For the old silver-based florin Con- virtually in tandem. ventionsmünze, fluctuations in the mar- ket price of silver resulted in deviations 4.2 Inflation and exchange rates of the market value of a silver coin from According to the monetary approach to its face value. When paper currency exchange rate determination, excessive began to play a role in money supply, a relative money supply will cause a silver premium expressed the relative ­currency to depreciate. It also raises credibility of silver coins against ­inflation expectations and over time in- banknotes and state notes. This was the

Table 1 History of inflation and exchange rates in Austria

Period Inflation history Inflation rate Exchange rate history

Average Standard annual deviation change in %

1812–24 Deflation Currency reforms, stable silver –4.8 6.5 premium after 1818 1825–44 Price stability 0.3 3.6 Stable silver premium 1845–63 Moderate inflation 3.0 5.6 Fluctuating silver premium 1864–73 Deflation compensated by Widely fluctuating silver premium subsequent inflation 0.7 4.1 1874–1904 Moderate deflation until mid-1890s –0.6 2.1 Silver discount, gold parity from 1892 1905–14 Moderate inflation 2.1 2.1 Gold parity maintained 1915–24 WW I and hyperinflation 381.5 878.2 Massive crown depreciation 1925–45 Virtual price stability Currency reform, gold parity of schilling upheld, from 1938 reichsmark 1.0 2.9 as new currency 1946–52 Post-WW II inflation Currency reform, multiple exchange 31.3 29.1 rates 1953–70 Moderate inflation Fixed exchange rate vis-à-vis the U.S. 2.8 1.5 dollar 1971–81 Austro-Keynesianism, inflation, oil Post-Bretton Woods uncertainty, price crises Austria turning to “hard” Deutsche 6.3 1.9 mark as anchor 1982–98 Moderate inflation 2.9 1.3 Hard currency policy 1999 to present Inflation at ECB target 1.9 1.1 Single European currency

Source: Author’s specifications.

MONETARY POLICY & THE ECONOMY Q3– Q4/16 71 Two centuries of currency policy in Austria

case in Austria during the Napoleonic following currency reform which wars, when the original credibility of brought silver convertibility to the new paper money was lost due to an exces- Austrian florin (for the years 1856– sive use of the printing press. Thereaf- 1858). The premium turned to a dis- ter, the silver premium was closely count in 1879 and remained close to linked to external and internal political zero until 1886. Because of a dwindling turbulences and related developments silver price in terms of gold, the silver in government finances. In 1818, the discount widened substantially to some premium peaked at 12 times its prewar 50% toward the end of the 19th cen- level, and it was only stabilized, in par- tury. Following the change in 1892 allel to a significant deflation, when the from the silver florin to the gold crown currency reform of the newly-founded as a new currency, the gold parity was OeNB was implemented. maintained until WW I (chart 2). Repeated government interventions Attempts to find simple associations to increase the money supply were mir- over the period from 1970 to 2015 be- rored in the erratic movement of the tween the current account (as a per- silver premium. After the paper florin centage of GDP) and effective exchange had been debased from silver in 1848, rate developments have not delivered the premium fluctuated widely from a meaningful results. Taking three-year low value of just 5% in 1856–58 to averages, there is just a very weak nega- some 40% in 1861. The low premium tive correlation (R2=0.04) between the episodes are explained in Pressburger current account as defined above and (1966) by a number of special factors percentage changes in the REER, and including (1) the reduction of banknotes only for the subperiod from 1970 to in circulation (1865 and 1874–1876); 1993. Interestingly, for the subperiod and (2) the preparation of the Vienna from 1994 to 2014, the correlation Currency Convention of 1857 and the turns positive (R2=0.20). It is quite

Chart 2 Silver premium (1848–1899) and gold premium (1863–1914) Index, price of paper money=100 150

140

130

120

110

100

90

80

70

60

50 1845 1850 1855 1860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 1915 Silver premium Gold premium

Source: AMECO.

72 OESTERREICHISCHE NATIONALBANK Two centuries of currency policy in Austria

possible that the signing of the Maas- ing the hard currency policy and the tricht Treaty in 1992 and the reforms period following euro adoption, budget following the European currency crisis deficits have often been anticyclical, of 1993 produced sustainable current which means that earlier war financing account surpluses which were not has been replaced by fights against eco- thwarted by real exchange rate appreci- nomic slack and unemployment. Since ations. However, a more convincing in- the late 1960s, as a rough trend, in- terpretation would require additional creasing budget deficits as a percentage analytical work. of GDP have been associated with ap- There is also a possible interconnec- preciations of the NEER and vice versa tion between current account develop- (chart 3). Theory is ambiguous about a ments and developments in relative in- positive or negative association between terest rates: Whenever the current ac- the two variables, but it is widely ac- count posts an increasing deficit, a rise cepted that growing budget deficits in the domestic interest rate could, may lead to higher domestic interest ceteris paribus, counter an incipient rates, which entail capital inflows and ­depreciation. Actual data for the period cause the domestic currency to appre- from the early 1970s to the late 1990s ciate.4 In the case of Austria’s hard cur- reveal rather weak negative correla- rency era with its virtually predeter- tions between relative bond yields (the mined monetary policy, the contrac- difference of secondary market yield tionary impact from NEER apprecia- data of ten-year Austrian government tion was compensated by moving in an bonds and, alternatively, German and expansionary fiscal direction, which U.S. rates) and current account bal- was in part corrected after joining the ances. Only in the following period euro area. Another interpretation may ­after euro adoption are the substantial run via third variables such as the state current account surpluses unequivo- of the economy: In an ailing domestic cally accompanied by comparatively economy automatic stabilizers rise and low interest rates in Austria. tax income suffers, thereby increasing In the post-WW II era, the infla- the budget deficit, but this situation is tionary phases of the 1970s and early also associated with dampened import 1980s also produced comparatively demand, which improves the current high NEER growth rates, while since account and entails a currency appreci- the mid-1990s moderate inflation has ation. However, there is also the well- moved hand in hand with just small known “twin deficits” hypothesis, ac- changes in the NEER. cording to which rising budget deficits will go hand in hand with rising cur- 4.3 Public finances, external rent account deficits and thus lead to ­accounts and the real sector currency depreciation (Feldstein, 1986). Whenever the printing press is in- As mentioned earlier, for a long volved, there is also an obvious connec- time real sector objectives, such as tion between the financing of govern- more GDP growth and lower unem- ment budgets and inflation. In Austria ployment rates, played at best an indi- this is particularly true for the early rect role in monetary and exchange rate 19th century. In recent decades, cover- policies. This certainly holds for the

4 For an overview of theoretical arguments and empirical findings on the relationship between budget deficits and exchange rates, see Hakkio (1996) and Saleh (2003).

MONETARY POLICY & THE ECONOMY Q3– Q4/16 73 Two centuries of currency policy in Austria

Chart 3 Nominal effective exchange rate and budget balance from 1961 to 2015 (with polynomial trends of the 4th order) % 8

6

4

2

0

–2

–4

–6

–8 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 NEER (percentage change) Budget balance (% of GDP) Polynominal trend of NEER (percentage change) Polynominal trend of REER (percentage change)

Source: OeNB, AMECO and author’s calculations.

19th century and for the early 20th cen- from wars and war-related debt financ- tury up to and including WW I. Inter- ing. During the 19th century the financ- dependencies between exchange rates ing needs of belligerent countries were and the real sector became relevant in met primarily by printing money, liter- the interwar period with the outbreak ally by banknotes and state notes and by of the . In the extending central bank credit to gov- post-WW II era the dominant policy­ ernments. In the aftermath of wars, intention was to adjust real sector vari- currency reforms often became neces- ables, in particular productivity, in sary to allow for a new start (as in 1811, such a way as to steer the ­targeted 1859, 1866, 1925 and 1947). ­average market exchange rate close to In the years following WW I, ex- a perceived equilibrium exchange rate. change rate policy proper evolved as an active instrument of steering the mac- 5 Summary roeconomy with the main objectives of This paper investigates Austria’s cur- controlling inflation and fostering pro- rency policies over the last 200 years, ductivity advances. An early appear- attempting to sketch historical develop- ance of an anti-inflationary exchange ments and uncover regularities and in- rate policy came a few years before terconnections with other economic WW I when the OeNB was mandated variables. During much of the first to keep the exchange rate of the crown 100 years under observation, Austria’s stable against other major currencies. exchange rate policy was targeted at es- During most of the period consid- tablishing and maintaining the credibil- ered here, Austrian currencies were ity of technical currency parities, in subject to fixed exchange rates, in the spite of activities like coinage debase- form of silver and gold standards in the ment and excessive printing of paper 19th century, as a gold-exchange stan- money. Dramatic changes in the mar- dard in much of the 20th century, and ket values of currencies mostly resulted with the euro as the single currency in

74 OESTERREICHISCHE NATIONALBANK Two centuries of currency policy in Austria

the early 21st century. In between, brief side effects. Given Austria’s adoption of phases of exchange rate flexibility pre- the euro, national exchange rate policy vailed, such as for the paper florin in has been relinquished in favor of a com- the 1880s and early 1890s and the mon currency which itself is floating post-Bretton Woods era of the early vis-à-vis third currencies. Austria’s 1970s. Before long, however, they transformation from one of Europe’s would give way to another peg system. few great powers before WW I to a A prominent form of linking the ex- small open economy closely tied to change rate to a stability anchor was the neighboring Germany thereafter largely “hard currency policy” of the 1980s explains the change from the early and 1990s, which served Austria well, ­specie standards to a preference for sta- allowing it to achieve the goals men- ble rather than flexible exchange rate tioned above without apparent negative regimes.

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Schmitz, S. W. 2016. The OeNB’s reaction to the end of the Bretton Woods system: tracing the roots of the Indicator. In this volume. Yeager, L. B. 1998. From gold to the euro: The international monetary system in retrospect. In: Dowd, K. and R. H. Timberlake, jr. (eds.). Money and the nation state: The financial revolution, government, and the world monetary system. The Independent Institute. Oakland. Transaction Publishers. 77–104.

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