EC120 week 18, topic 13, slide 0 The International Gold Standard Topics: Monetary standards International money: a brief chronology Adoption of the Gold Standard from mid-19th century Complications: 1. Bimetallism; 2. capital flows & interest rates The Gold Standard in practice, 1880−1914 Financial crises and monetary policy `Lender of Last Resort’ & the Bagehot principle The mechanism of international adjustment Summing up: interpretation and assessment

EC120 week 18, topic 13, slide 1 Monetary standards A spectrum of standards between the extremes of: –Adopt another currency altogether –Peg currency to a precious metal (“fixed parity”) –Floating exchange rates with other currencies Some currencies were pegged to two (or more) metals

EC120 week 18, topic 13, slide 2 International money: a brief chronology Prior to mid/late 19C: various, based on precious metals International Gold Standard, c1870−1914 Interwar period, 1918−39: `Gold Exchange Standard’ Bretton Woods, 1945−71: Adjustable pegged exch. rates Since 1971: mixed `system’, mostly quasi-floating

EC120 week 18, topic 13, slide 3 Adoption of the Gold Standard from mid-19C Move to gold was piecemeal How the Gold Standard worked, perhaps: –Exports>Imports: inflow of gold –Imports>Exports: outflow of gold –Hume’s `specie flow’ model: exports <> imports  changes in money (gold) stock  goods’ prices  exports = imports  `external balance’

EC120 week 18, topic 13, slide 4 Complications, 1: Bimetallism What is `bimetallism’? –Currency pegged to two metals, e.g. gold and silver Often attractive when precious metals are used as money In practice one metal, gold, became dominant But the silver lobby did not die easily: “... You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold.” William Jennings Bryan, 1896

EC120 week 18, topic 13, slide 5 Complications, 2: capital flows & interest rates Δ(money stock) = (exports − imports) + net capital inflow Capital flows include borrowing/lending as well as gold `International Trilemma’: allows only two of − a.Fixed exchange rates (e.g. gold standard) b.Capital mobility c.Independent monetary policy To uphold the gold standard, (c) was abandoned

EC120 week 18, topic 13, slide 6 The Gold Standard in practice, 1880−1914 Varieties of `Gold Standard’: –Only a core group issued gold coins (specie standard) –Some countries issued a mixture (inc. token currency) –Many countries held foreign exchange as reserves Worldwide deflation: c1873 to c1896 declining price levels

Financial Crises & Monetary Policy More sophisticated finance supported trade and industry – But recurring crises had widespread impact Expanding international trade links increased the need for stable monetary standards: unsystematic adoption of gold or silver Twin goals of state monetary policies: –Internal balance: stable price level and prosperity –External balance: to maintain the currency’s convertibility Inadequate financial supervision of banking systems to achieve policy objectives EC120 week 18, topic 13, slide 7

The Bagehot Principle Policy problem: to maintain both internal & external balance External balance was threatened if gold flowed abroad Internal balance was threatened if banks fail (or in distress) Bagehot principles: a lender of last resort that –Lends freely –On good collateral, but –At penal (high) interest rates Bagehot problem: moral hazard EC120 week 18, topic 13, slide 8

EC120 week 18, topic 13, slide 9 The mechanism of international adjustment Very little gold was shipped from one country to another Were the “rules of the game” obeyed? –Central banks manipulated interest rates –Central banks co-ordinated their policies –In times of `stress’ convertibility was suspended

EC120 week 18, topic 13, slide 10 Stability of the international Gold Standard Adherence to the Gold Standard: was seen as a –“Good Housekeeping Seal of Approval” Stability/instability at the periphery: mixed experience Stability among the core nations seemed robust

EC120 week 18, topic 13, slide 11 Summing up: interpretation and assessment Why the international gold standard worked: –Kindleberger’s `theory of hegemonic stability’ –Eichengreen emphasises credibility and co-operation International stability a cause or an effect of the G.S.? How long could it have survived?