A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Bordo, Michael D.; Schwartz, Anna J. Working Paper The Specie Standard As A Contingent Rule: Some Evidence for Core and Peripheral Countries, 1880-90. Working Paper, No. 1994-11 Provided in Cooperation with: Department of Economics, Rutgers University Suggested Citation: Bordo, Michael D.; Schwartz, Anna J. (1994) : The Specie Standard As A Contingent Rule: Some Evidence for Core and Peripheral Countries, 1880-90., Working Paper, No. 1994-11, Rutgers University, Department of Economics, New Brunswick, NJ This Version is available at: http://hdl.handle.net/10419/94338 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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Schwartz Department of Economics National Bureau of Economic Research Rutgers University 269 Mercer Street, 8th Floor New Brunswick, New Jersey 08903 New York, New York 10003 and N.B.E.R Paper prepared for: Historical Perspectives on the Gold Standard: Portugal and the World. Editors: Barry Eichengreen, Jorge Braga de Macedo and Jaime Reis. Draft: August 1994 1. Introduction The classical gold standard era from 1880 to 1914, when most countries of the world defined their currencies in terms of a fixed weight (which is equivalent to a fixed price) of gold and hence adhered to a fixed exchange rate standard, has been regarded by many observers as a most admirable monetary regime. They find that its benefits include long-run price level stability and predictability, stable and low long-run interest rates, stable exchange rates (McKinnon, 1988), and hence that it facilitated a massive flow of capital from the advanced countries of Europe to the world's developing countries. Others have taken a less favorable view of the gold standard's performance. Some criticize the record of relatively high real output and short-term price variability (Bordo, 1981; Cooper, 1982; Meltzer and Robinson, 1989), and some have faulted it for subordinating domestic stability to the maintenance of external convertibility (Keynes, 1930). A persistent critique of the gold standard is that it provided a favorable experience for the core countries (England, France, Germany, and the United States), but a less favorable experience for the peripheral countries of the developing world (De Cecco, 1974). For the core countries the balance of payments adjustment mechanism was stable, so few crises occurred; the peripheral countries, by contrast, were subject to shocks imported under fixed exchange rates from abroad and frequently suffered exchange rate crises and a destabilized growth pattern. An alternative approach to these issues of gold standard history posits that adherence to the fixed price of specie, which characterized all convertible metallic regimes including the gold standard, served as a credible commitment mechanism to monetary and fiscal policies that otherwise would be time inconsistent (Bordo and Kydland, 1992; Giovannini, 1993). On this basis, adherence to the specie standard rule enabled many countries to avoid the problems of high inflation and stagflation that troubled the late twentieth century. The specie standard that prevailed before 1914 was a contingent rule, or a rule with escape clauses. Under the rule specie 1 convertibility could be suspended in the event of a well understood, exogenously produced emergency, such as a war, on the understanding that after the emergency had safely passed convertibility would be restored at the original parity. Market agents would regard successful adherence as evidence of a credible commitment and would allow the authorities access to seigniorage and bond finance at favorable terms. On this view, the core countries were good players of the classical gold standard game - - they adhered strictly to the rule, whereas many peripheral countries were not. Some never adhered to the rule. Others joined it when conditions were favorable to them ostensibly to obtain access to capital from the core countries, but they quickly abandoned it when economic conditions deteriorated. The interwar gold standard can be regarded as an extension of the pre-1914 system because it was based on gold convertibility. However, it was less successful because the commitment to convertibility was often subordinated to other politically induced objectives. The Bretton Woods international monetary system can be regarded as a distant relative of the classical gold standard in that the center country, the United States, maintained gold convertibility. It was also based on a rule with an escape clause -- parities could be changed in the event of a fundamental disequilibrium. However, it differed from the basic specie standard rule in that a credible commitment to the fixed parity was not of such primary importance. This paper surveys the history of the specie standard as a contingent rule from the early nineteenth century when most countries were still on a bimetallic or silver standard until the gold standard's final collapse in the late 1930s. As a comparison we also briefly consider the Bretton Woods system and the recent managed floating regime. We then present some evidence on the economic performance of the core and a number of peripheral countries under the various regimes. 2 Section 2 defines the contingent specie standard rule and discusses how the commitment to convertibility was maintained. Section 3 presents and discusses a chronology of adherence to the rule by 21 countries under variants of the specie standard prevailing before World War II. A similar chronology is included for the Bretton Woods system. Section 4 offers some graphical evidence on capital flows 1865 to 1914 from England to two countries of recent settlement -- Argentina and the United States -- during episodes of both suspension and adherence to convertibility. It suggests that adherence to the rule may have had some influence on the decision by England to invest abroad. Section 5 presents evidence on economic performance for 21 countries (both core and peripheral) across several regimes. Such evidence may shed light on whether differing economic performance can explain why some countries successfully adhered to the rule and others did not, or whether adherence/nonadherence may have influenced performance. We examine the stability of both nominal and real macro variables across four regimes (pre-1914 gold standard; interwar gold standard; Bretton Woods; the subsequent managed exchange rate float). We then present measures of both demand shocks (reflecting policy actions specific to the regime) and supply shocks (reflecting shocks to the environment independent of the regime). These measures allow us to determine whether adherents to the rule consistently pursued different policy actions from nonadherents, and whether persistent adverse shocks to the environment may, for some countries, have precluded adherence to the rule. The paper concludes with answers to the questions: how successful was the specie standard rule as a contingent rule; why it was successful when it was; and why some countries adhered while others did not. 2. The Specie Standard as a Contingent Rule 2.1 The Domestic Gold Standard A specie standard has been traditionally viewed as a form of monetary rule or constraint over monetary policy actions. Following a rule, such as adherence to the specie standard, which 3 would cause the money supply to vary automatically with the balance of payments, was viewed as superior to entrusting policy to the discretion of well-meaning and possibly well-informed monetary authorities (Simons, 1951).1 In contrast to the traditional view, which stresses both impersonality and automaticity, the recent literature on the time inconsistency of optimal government policy regards a rule as a credible commitment mechanism binding policy actions over time. The absence of a credible commitment mechanism leads governments, in pursuing stabilization policies, to produce an inflationary outcome (Kydland and Prescott, (1977); Barro and Gordon, (1983). In a closed economy environment, once the monetary authority has announced a given rate of monetary growth, which the public expects it to validate, the authority then has an incentive to create a monetary surprise to either reduce unemployment or capture seigniorage revenue. The public, with rational expectations, will come to anticipate