by Guillaume Bazot (University Paris 8), Eric Monnet (Banque de France, Paris School of Economics & CEPR) and Matthias Morys (University of York)
This research will be presented during the EHS Annual Conference in Belfast, April 5th – 7th 2019. Conference registration can be found on the EHS website.
A great deal of research has drawn on the classical gold standard (1870s-1914) – an earlier and highly successful system of fixed exchange rates – to provide guidance for Europe’s monetary union (EMU). Such historical inspiration initially informed the design of the euro and then, since the outbreak of the Eurozone crisis in 2010, how to fix the flaws of the common currency.
Researchers have offered very different lessons from the past, yet they all share one key feature: the gold standard as a highly rigid system, robbing countries of their monetary policy and leaving them potentially unable to respond to major shocks.
Our research, to be presented at the Economic History Society’s 2019 annual conference, takes the opposite perspective: the extraordinary stability of the gold standard stems from the fact that it was precisely not a rigid framework. Central banks retained far more room for manoeuvre than is conventionally acknowledged, and they knew how to use this policy space for their own purposes.
Drawing on a unique high-frequency data set for all 21 central banks of the gold standard period (arduously collected by Bank of France statisticians at the time but then shelved in the bank’s archives, where we found them), we estimate how other central banks reacted when ‘the conductor of the international orchestra’ (as Keynes named the Bank of England) raised interest rates.
Our results show that there was no ‘rule of the game’ that countries automatically followed after a rate rise. Instead, we document that central banks followed a variety of – economically well-defined and econometrically clearly identifiable – strategies with the aim of mitigating the impact of a foreign central bank decision on the domestic economy.
Intriguingly, two important strategies pursued at the time – sterilisation and capital controls – have clear parallels with key policies implemented in the Eurozone since 2010.
This is especially the case with the (highly) asymmetric distribution of loans for the ‘long-term refinancing operations’ (LTROs) across countries (in order to improve the convergence of credit conditions), macroprudential policies (to tame asymmetric credit booms), the use of ‘emergency liquidity assistance’ (ELA) by national central banks and the use of capital controls as a last resort in Cyprus and Greece.
It is often said that the euro started out as a modern-day gold standard (clear rules, common monetary policy, separate fiscal policies) but has developed into something else in recent years. By contrast, our research shows that the gold standard always possessed certain features of flexibility – characteristics that the euro area had to introduce in response to the Eurozone crisis. In its move away from one-size-fits-all monetary policy, today’s EMU arguably resembles the classical gold standard more than it did before 2010.