Monetary Policy Regime Changes–Political Economy and Distributional Effects∗ Pamfili Antipa y Banque de France and Paris School of Economics September 2017 Preliminary Abstract I analyze the policy choice of resuming the gold standard after the French Wars (1793-1815) in the face of an exceptionally high debt burden. The choice was nei- ther inevitable nor based on economic rationale. Rather, it hinged on the identity of public creditors and the geographical distribution of economic hardship and po- litical representation. Resuming the pre-war parity of the pound induced large scale deflation and recession. This outcome was politically feasible because the franchise was limited and political repression was comprehensive. Means and causes of the resumption were political. The paper informs current policy choices between main- taining a fixed exchange rate and restructuring an outstanding debt overhang. Keywords: Monetary policy regime change, distributional effects of monetary policy, po- litical economy of monetary policy, fiscal redistribution. JEL: N43, E42, H23, H60. ∗The views expressed herein are those of the author and do not necessarily reflect those of the Banque de France. All remaining errors are mine. I thank Andrés Álvarez, Vincent Bignon, Jean Cartelier, Christophe Chamley, Rebeca Gomez Betancourt, Pierre-Cyrille Hautcoeur, and Gilles Postel-Vinay for their very helpful comments. ypamfi[email protected] 1 1 Introduction Public expenditures can be financed by levying taxes, emitting debt, issuing money, or any combination of the three. The distribution of political power governs the exact pol- icy mix used to fund outlays by determining the identity of those who pay–taxpayers, public creditors, or both. That is to say, politics rather than economics determine the “who” and the “how” of funding public expenditures (Mill 1865, p.250). The policy mix that can be implemented also hinges on a number of more or less struc- tural characteristics of the polity. The framework for conducting monetary policy–the monetary policy regime–is one of them. Monetary financing of public expenditures is easier under certain monetary regimes. Changes in the monetary regime to facilitate public spending are driven by fiscal and thus political calculus. The link between monetary policy regimes, public finances, and the distribution of polit- ical power crystallized when Britain returned to the gold standard in 1821. During the French Wars (1793-1815), inflation occurred along with the substantial accumulation of public debt. As prominent bankers, merchants, and economists had presaged, resuming the gold standard at the pre-war parity of the pound induced large-scale deflation and recession. The policy choice of returning to the gold standard in the face of an exceptionally high debt burden was not based on economic rationale (Fetter 1965, p.285). It rather hinged on the identity of public creditors and the geographical distribution of economic hardship and political representation. In particular, resumption secured a sought-for return to the pre-war wealth distribution at the admitted price of a less efficient allocation of capital.1 By augmenting the real value of outstanding debt it also meant a fiscal transfer from tax payers to public creditors. Amid post-war depression and deflation, severe social tensions erupted. Social discon- tent manifested in calls against resuming the gold standard and in favor of parliamentary reform–the ultimate lever over taxation. The return to the gold standard at the old par 1Hansard HL Deb 21 May 1819 vol 40 cc 640-641. 2 was seen as part of a fiscal system that extracted high taxes and that used the revenue to finance the military establishment and rentiers living on income from government loans (Daunton 2001, p.18). The calls against resumption and for parliamentary reform were both symptomatic of the same issue: the waning consent with the fiscal constitution. Social upheaval was repressed and franchise reform only occurred in 1832. It consisted in a mostly geographic redistribution of elite voting rights and was granted when the incentives of the to-be-enfranchised had been aligned with those of the traditional public creditors (North et al. 2009, pp.213-5). The newly institutionalized savings banks made sure that the enfranchised gained an interest in the reimbursement of the public debt. This safeguarded the overriding policy objective of the period, the public debt. My narrative is new in several aspects. By analyzing verbatim transcripts of parlia- mentary debates, I find that distributive rather than monetary reasoning governed the decision to resume the gold standard. The monetary policy regime change is, thus, to be understood as a part of a fiscal policy mix that granted a return to the pre-war dis- tribution of wealth. In addition, on the basis of hitherto unexploited data, I reconstruct how the Bank of England generated profits and find that its opposition to the modalities of resumption was bona fide. This adds a new layer to the debate regarding the degree of discretion in the Bank’s monetary conduct and considers the institutional fabric of monetary policy more generally (Flandreau 2007). I also show how coping with the debt overhang from the French Wars eventually influ- enced the extension in the parliamentary franchise, i.e. the reform of the fiscal constitu- tion. As a counterpart to investing in the public debt, the middle classes gained control over taxation, public expenditures and debt. The reformers–the Whigs–shaped the new electoral landscape to their advantage. While in the opposition, they were also able to exploit the disastrous consequences of resuming the gold standard for party advantage (Hilton 1977, p.40). Returning to a fixed exchange rate rather than restructuring the outstanding debt overhang came with high social costs. Eventually, social translated into political costs. These insights are of timeless relevance and politicians in Southern Europe have painfully gained them. 3 It took an extensive analysis of primary sources and hand-collected data to analyze deci- sions made in light of the information available to and the beliefs held by policy makers in real time (Blaug 1990). Verbatim transcripts of parliamentary debates, parliamentary reports containing evidence provided by contemporary experts and specifically prepared and hitherto unexploited data uncovered policy makers’ incentives. The latter shaped policy proposals and it is against intended outcomes that the obtained should be mea- sured. Against this yardstick, resuming the gold standard was a great political success: it granted the return to the pre-war wealth distribution and harmed the governing party. The exact same reasons also implied that resumption meant an economic calamity. The remainder of this article is organized as follows. The next section briefly describes the fiscal tensions that led to the suspension of the gold standard and analyzes the blueprint for resumption, the Bullion Report. Section three depicts the burden left by the French Wars and studies the people, the arguments, and the actions that shaped and accompanied the return to the gold standard. Based on the link between fiscal pressure and social discontent, section four explains the timing of the 1832 franchise extension. The final section concludes. 2 Setting the Stage: the Bullion Report’s Terrible Policy Advice The French Wars, 22 years of almost uninterrupted warfare between 1793 and 1815, exerted extreme political and financial pressures. Britain went into the wars with an already high debt-to-GDP ratio–127 percent, a relic from the American War. Imple- menting the usual tax smoothing approach, the first four years of the wars were debt financed (Antipa and Chamley 2017). This led to a 50 percent increase in outstanding debt. Interest rates on the benchmark instrument of public debt–a three percent per- petual, the consol–increased by 200 basis points. The Treasury borrowed short-term from the Bank of England, whenever unforeseen ex- penditures occurred. With the Bank charter renegotiable at will, the Bank could hardly refuse requests for credit from the Treasury in times of war (Broz and Grossman 2004). 4 During the French Wars, it never did.2 For an average war year, roughly 30 percent of total revenues originated in short-term debt issues. The Bank absorbed roughly two- thirds of these issues.3 The internal fiscal tensions were exacerbated by capital flows from the continent (Neal 1991). In these circumstances, French military actions in February 1797 triggered bank runs with depositors hoping to convert notes into gold coin. In order to continue supply- ing the Treasury with cash, the Bank ceased payment of its notes in gold on the 27th of February 1797.4 Suspension of the gold standard, “indispensably necessary for the public service” created a payment system, in which the Bank and the Treasury controlled the money supply. Beginning in 1809, the paper pound’s exchange rates into gold and foreign currencies– the measures contemporaries used to gauge inflationary tensions–started to experience marked declines. These evolutions prompted government to appoint an investigating committee. The Report from the Select Committee on the High Price of Gold Bullion, the Bullion Report in short, was discussed in Parliament in May 1811.5 According to the Committee, the Bank’s over-issue of notes produced the pound’s devaluation. Over- issue was only possible because the suspension of the gold standard had relieved the Bank of its obligation to exchange its notes against gold on demand. The Committee thus recommended to resume the gold standard over a period of two years, regardless of the continuation of the war. Prices had increased by the time the Bullion Report was drafted; the Bank’s note circu- lation had began to do so right after the suspension in 1797. As can be seen in Figure 1, the aggregate price level had risen by roughly 30% in 1810. The Bank’s note circulation, 2Report from the Secret Committee on the Expediency of the Bank Resuming Cash Payments (1819).