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Q3-Q4/16 – Two Centuries of Currency Policy in Austria

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Q3-Q4/16 – Two Centuries of Currency Policy in Austria Two centuries of currency policy in Austria 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 currencies 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 euro 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, central bank, 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 gold standard 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 Vienna 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 MONETARY POLICY & THE ECONOMY Q3– Q4/16 61 Two centuries of currency policy in Austria 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 banknote 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 Bretton Woods system 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.
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