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Review of Development Finance 1 (2011) 131-149
The Latin Monetary Union: Some evidence on Europe's failed common
currency
Kee-Hong Bae^1, Warren Bailey b'*
a Schulich School of Business, York University, Room N218 SSB, 4700 Keele Street, North York, Ontario, Canada M3J1P3 b Johnson Graduate School of Management, Cornell University, Sage Hall, Ithaca, NY 14853-6201, United States
Available online 21 April 2011
Abstract
The Latin Monetary Union was initiated in 1865 by France, Belgium, Italy, and Switzerland. We find that LMU membership or adoption of a gold standard is frequently associated with lower volatility of private bill yields, bond yields, inflation, and deviations from Purchasing Power Parity. However, neither standard induces convergence with LMU leader France or gold standard leader Great Britain. Bond yield spreads indicate that adoption of the gold standard is more credible than membership of the LMU. Italy is an outlier, perhaps due to errant fiscal and monetary policies. A comparison to data from the modern EMS/EMU confirms that the LMU was a weaker and less credible currency arrangement. © 2011 Production and hosting by Elsevier B.V. on behalf of Africagrowth Institute.
JEL classification: E5;F3;F4
Keywords: Currency union; European Monetary Union; EMU; Latin Monetary Union
1. Introduction
The implications of common currency areas, pegged currencies, and currency boards are important to economists, policy makers, investors, and ordinary citizens. The European monetary system (EMS) and recent adoption of the euro rest on the idea that currency union will further economic growth, temper volatility, and reduce transactions costs. Ongoing debates in Denmark and the U.K. indicate concerns about the loss of economic sovereignty and the potential transmission of unwanted foreign economic shocks if the euro is adopted. A peg to the U.S. dollar has persisted for twenty years in Hong Kong, and recently the dollar has been adopted by Ecuador and El Salvador. On the
* Corresponding author. Tel.: +1 607 255 4627. E-mail addresses: kbae@schulich.yorku.ca (K.-H. Bae), wbb1@cornell.edu (W. Bailey).
1 Tel.: +1 416 736 2100x20248.
1879-9337 © 2011 Production and hosting by Elsevier B.V. on behalf of Africagrowth Institute.
Peer review under responsibility of Africagrowth Institute, Republic of South Africa.
doi:10.1016/j.rdf.2011.03.001
other hand, a dollar peg has been blamed for contributing to the recent catastrophic collapse of the currency, banking system, and economic output in Argentina.
It is difficult to predict the impact of adopting a common or pegged currency. On the one hand, a pegged regime can increase the volatility of domestic macroeconomic and financial indicators (Frenkel and Mussa, 1980). This is because foreign economic shocks can no longer be absorbed by exchange rate fluctuations and, therefore, are transmitted directly to domestic prices, interest rates, and economic growth. Heightened domestic volatility can be particularly pronounced if the credibility of a common currency or peg is questionable (Flood and Hodrick, 1986). On the other hand, some studies (Fratianni and von Hagen, 1990; Artis and Taylor, 1994) find that the volatility of domestic prices, interest rates, money, and output is dampened after adoption of the European monetary system. This may result from more international trade and investment, less exchange rate volatility, or adherence to the conditions for EMS entry. Other empirical evidence finds that the volatility of domestic macroeconomic indicators (Baxter and Stockman, 1989; Flood and Rose, 1995; Rose, 1995) and stock market returns (Bodart and Redding, 1999) do not depend on whether the exchange rate regime is fixed or flexible.
Successful adoption of a common currency or peg implies a degree of convergence between economies that share the same currency. If a fixed exchange rate increases trade and investment, economic conditions across member countries will tend to converge. At a minimum, the lack of a flexible exchange rate
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to absorb shocks implies more commonalities across economies that share a currency or monetary system. In cases like the EMS, macroeconomic convergence on a number of dimensions is mandated. Furthermore, arbitrage should drive interest rates and bond yields closer together. Thus, we can predict that correlation of economic indicators across countries will increase when they share a common currency or other joint monetary arrangement. Of course, the same issue of credibility that can induce heightened volatility in a currency arrangement can also reduce crosscountry correlations if credibility differs across member states. There is some evidence from European securities markets that declining volatility (Bodart and Redding, 1999) and convergent risk premiums (Hardouvelis et al., 2006, 2007; Bekaert et al., 2010) are associated with EMS and the adoption of the euro.
The purpose of our study is to examine the financial and economic record of the Latin Monetary Union, a 19th century attempt at forging a common monetary policy and virtually common currency. We examine the volatility and correlation of interest rates, bond yields, inflation, and trade across member and non-member states during the time when this agreement was in force in one form or another. We use data from this era to develop fresh evidence on the implications of adopting (or, in this case, attempting to adopt) a common currency policy. The Latin Monetary Union is of particular interest because it originated in Western Europe and, thus, is an historical predecessor of today's common European monetary arrangements. Our results indicate that the volatility of interest rates, bond yields, inflation, trade, and deviations from Purchasing Power Parity are typically lower when a country joins or follows the LMU, though this effect is more pronounced for countries adopting an alternative rigorous monetary system, the gold standard. We also find no evidence that LMU membership increases the correlation of interest rates, bond yields, and inflation with the key LMU member, France. It is also the case that correlation with the key gold standard country, Great Britain, does not increase under a gold standard. Furthermore, credibility (as measured with the spread of bond yields over the British bond yield) under a gold standard is much more striking than with membership of the LMU. Throughout our results, it is clear that Italy's volatile economic conditions and policies distinguish it from other countries, in spite of its membership of the LMU since its inception. In contrast, some comparative results from the modern EMS/EMU era suggest that EMS/EMU membership converges bond yields and inflation rates to those of Germany, perhaps most prominently for Italy.
The balance of the paper is organized as follows. Section 2 provides a detailed description and chronology of the development of the LMU. Section 3 outlines our methodology and data. Section 4 presents and discusses results. Section 5 presents some comparable results on the modern European monetary system, and discusses the applicability of our LMU era results to understanding modern currency systems. Section 6 is a summary and conclusion.
2. The Latin Monetary Union
both gold and silver coins could circulate. Furthermore "free coinage" meant that anyone could bring metal to the mint to be coined into standard gold or silver money. The weight, fineness, and denomination of coins defined a "mint ratio" for the value of gold versus silver. If, for example, a silver one-franc coin contained 5 g of silver and a gold twenty-franc coin contained six 2/3 g of gold, the implied mint parity was 15—1.2 The system was intended to adjust naturally to changes in the relative market value of the two metals. If, for example, silver became more valuable, silver coins would be removed from circulation by arbitrageurs while additional gold would be brought to the mint for coinage and circulation. As more silver was sold in the bullion market while more gold disappeared into coin, the relative prices of the two metals would revert back towards the mint ratio.
Real world events and frictions complicated the workings of such a system. Starting in the late 1840s, large gold discoveries in California and Australia greatly increased the global supply of gold and drove up the market price of silver relative to gold as is evident in Fig. 1. As a consequence, silver coins were often removed from circulation and melted, yielding a dearth of small coins to facilitate commerce. Some countries responded by producing "subsidiary" silver coins, that is, small silver coins whose metallic value was substantially less than the coin's face value. Such coins were less likely to be withdrawn for melting and, therefore, were available to support commerce. However, these coins led to other problems. When, for example, Switzerland reduced the purity of her small silver coins to 80% on 31 January 1860, arbitrageurs used the new coins to purchase French and Belgian coins of higher purity and remove them from circulation for melting. France consequently banned small Swiss silver from circulation on 14 April 1864 and reduced the fineness of her own small silver coins to 83.5% on 24 May 1864. Italy's neighbors suffered a flood of Italian minor silver coins when Italy reduced the fineness of her small silver coins to 83.5% starting 24 August 1862. Larger and purer silver coins also caused problems between western European neighbors. When, for example, Belgium adopted the silver standard in 1850 and began to produce new 5 franc silver coins, they were immediately replaced by arbitrageurs who bought the new coins with worn old French 5 franc coins of reduced weight, melted them, and pocketed the difference.
France, Belgium, Italy, and Switzerland agreed to form the Latin Monetary Union (LMU) at the conclusion of a conference on 23 December 1865 and to take effect on 1 August 1866. Recognizing the potential for lowered transactions costs and increased price transparency, the treaty confirmed standard sizes for gold and silver coins of union members, guaranteed the acceptability of each member's coins in settling public and private payments in all member states, and attempted to constrain the stock and flow of minor silver coins to a reasonable amount based on each country's population. However, Willis (1901) notes that the Union "had simply provided for a uniform
At the beginning of the nineteenth century, many countries found themselves with bimetallic monetary systems under which
2 For example, the ratio was 16 for France and 15.5 for the U.S. during their respective bimetallic periods.
Fig. 1. Relative price of gold and silver at London. The plot shows monthly high and low prices for silver. Source is Pixley and Abell (1933). The critical mint ratio of France, 15.5, established in 1803 implies a price of slightly less than 61 pence per ounce given the amount of fine gold that defined the British pound.
fineness and weight of the coins of the different countries, but had not even prohibited issues of paper or dictated the amount of coin which should be issued. The limitation of the coinage of silver had been merely intended as a means of protecting the members of the union from one another's over-issues."
Less than a few months after ratification of the treaty, Italy suspended the convertibility of her banknotes into metal coins and put into circulation huge numbers of small denomination banknotes. Italy's small silver coins, in turn, flowed into France, Belgium, and other neighboring economies. The Pontifical State, the only remaining holdout from newly unified Italy, expressed an interest in joining the LMU but reversed course in 1868 due to limits on minting of minor silver coins. On 17 February 1870, Pontifical minor coins were banned from circulation in France, particularly as it was found that the coins claimed to be of 83.5% purity but were often only 83.167%. The flow of such coins ceased when the Pope's remaining territories were incorporated into Italy on 20 September 1870. Greece's admission to the LMU was associated with a similar problem. To avoid a massive flood of small Greek coins, Greece agreed that all coins would be produced at the Paris Mint and shipped directly to Greece. However, small Greek silver coins were found circulating in Paris within weeks after the agreement was put in force. All these cases were
associated with fiscal deficits and rapid money supply growth in the over-issuing countries.
Such problems persisted, and were aggravated by continuing falls in the price of silver (Fig. 1). Some members acted to restrict the supply of silver coins by suspending the right of "free coinage" of silver. In November 1878, a revised treaty banned the minting of new full weight five-franc coins and imposed on Italy a timetable for redeeming her small silver coins and small banknotes. Negotiations resulted in a less harsh deal for Italy but by 30 July 1879 "free coinage" of silver was eliminated. Continuing problems with silver led France, in March 1884, to demand full redemption of outstanding silver coins by their issuers, particularly if an issuing country planned to leave the Union. Countries with large amounts of such silver coins circulating in Europe switched tactics afterwards, with Italy and Belgium voicing support for a pure gold standard in the hopes that they could negotiate favorable terms for the retirement of their silver coins held in France, Switzerland, and other neighbors. A treaty revision in December 1885 specified terms for redemption. In the middle 1890s, Italy was still demanding concessions on redemption and experiencing shortages of pocket change as her silver coins were exported to her neighbors.
Table 1
Currency regimes from early 19th century to outbreak of First World War (June 1914).
Switch from Switch from Switch from silver
bimetallism to gold bimetallism to silver to gold
Other events and notes
Joined Latin Monetary Union
France
Belgium
November 1873
31 January 1874 6 August 1876
31 January 1874
28 December 1850
Switzerland
Germany Netherlands
United Kingdom Austria-Hungary
Denmark Finland
Greece
Portugal
Russia
Spain Sweden Turkey Canada
South Africa U.S.A.
December 1871 31 January 1874
29 July 1854
12 February 1873
1 January 1879 14 March 1900
December 1872
18 December 1873 31 January 1874
Late 1871
12 July 1873 31 October 1873
6 June 1875 December 1877
2 August 1892 27 May 1873 9 August 1877
January 1897
30 May 1873
26 June 1893
Convertibility of paper money suspended from 14 July 1870 to 13 December 1877
De facto bimetallism when French gold coins permitted to circulate, 4 June 1861
Varied local monetary systems prior to 1861. With Unification, adopted de facto gold standard 24 August 1862. Convertibility of paper money suspended from 1 May 1866 to 11 April 1884, 21 February 1894 to December 1913.
Varied local monetary systems prior to 1848. On silver through 1860.
Fully on gold starting 1821
On paper standard from 1848 to 1858, 1866
to 1892, and other times.
On paper standard except for 1869-1877.
On paper 19 July 1891. Pegged to pound 22 May 1911
Often on a paper standard.
On paper from 1883 on.
Often on a paper standard.
On gold starting 1858. Pegged to dollar 4
May 1910
Pegged to British pound.
Convertibility of paper money suspended
1862-1878
23 December 1865
23 December 1865
23 December 1865
23 December 1865
9 August 1877
10 April 1867
1 January 1869
19 October 1869
In many cases, more than one date is indicated. We designate a primary event date (used for computing our regime dummy variables) with bold type. Some events, such as suspension of free coinage of silver, constitute virtual adoption of gold, referred to as a "limping gold standard" or "étalon boiteux". Other events constitute virtual adoption of the LMU system. Dates of such episodes are indicated in italics. Sources include Willis (1901), Einaudi (2001), Global Financial Database (2001), Kindleberger (1993), Bordo and Capie (1994), and Fratianni and Spinelli (1997).
Table 1 summarizes the currency regimes in force during the period we study. As the table indicates, it is often difficult to distinguish shifts in policy as many gradual changes were experienced. In particular, there was often a gradual movement towards a gold standard (stopping the free coinage of large silver coins, stopping all production of such coins, removing them from circulation, de facto or de jure acceptance of foreign gold coins into circulation), rather than a clear-cut change in standard. We can, however, characterize several time periods of the Union's history. From its inception in 1865 through about
1873, the Union may be thought of as bimetallic. Starting in late 1873, more measures to restrain silver money appear. For example, LMU members agreed to suspend free coinage of silver as of 31 January 1874. Willis (1901) describes the period starting November 1878 as the "period of suspension" during which LMU members stopped producing large silver coins. He describes the period starting 1886 as the "period of compulsory redemption" during which more pressure was put on errant LMU members to redeem their subsidiary coins held by other members.
Although the Union survived in one form or another until 1925, it was not considered a success. Some member states typically ran budget deficits and attempted to "export inflation" to others in the form of large numbers of minor silver coins. Keeping the Union together was often seen as little more than a ploy to avoid the forced redemption of those coins if a member state left the Union or if the Union dissolved: the weaker states did not believe they could afford to retire their minor coins in gold and, thus, kept the Union alive. The strong, leading member of the Union, France, felt a need to avoid pushing weaker neighbors to the financial brink and, in effect, subsidized them. The outbreak of the First World War in June 1914 led to the general suspension of gold coinage and effectively ended what was left of the Union.
Since the LMU can be thought of as Europe's first broad common currency arrangement, it is useful to briefly summarize the development of today's European monetary system. In March 1979, the European monetary system (EMS) and its exchange rate mechanism (ERM) came into force. Under the ERM, exchange rates were permitted to fluctuate in bands ranging from 2^% to 15%, depending on the particular country. Conventional central bank tools were to be used to keep exchange rates within the agreed bands but, with persistent differences in inflation and other economic conditions across member states, there were repeated adjustments to target exchange rates. On 15 September 1992, Britain and Italy officially exited the ERM, Finland, Norway, and Sweden exited unofficially, and rates were realigned for Spain, Portugal and Ireland. In August 1993, the bands were widened for remaining members.
More recently, member states agreed to converge domestic economic conditions by adhering to limits on such variables as government borrowing, inflation, and bond yields. On 31 December 1998, the Irrevocable Euro Conversion Rates were published, defining fixed exchange rates for each member currency and the new euro unit of the European Monetary Union (EMU). Member states also agreed to yield their power to create money to the European Central Bank (ECB). At the start of2002, Euro coins and notes went into circulation in member countries, formally replacing the individual currencies of member states.
3. Research design
3.1. Methodology
As described in more detail below, the biggest constraint on our research is the availability of data. In some cases, we have access to annual data only while in others there is no recorded information at all. Therefore, we confine our statistics to simple unconditional variances and correlations within sub periods, linear regressions including time period dummy variables, and tests for statistically significant differences across sub periods.
We focus our tests on several questions implied by our previous discussion and by the nature of the LMU. A key aspect is to benchmark the LMU against the gold standard. The classical gold standard was a rigorous monetary system demanding that gold coin or paper money freely convertible into gold be strictly maintained (Bordo and MacDonald, 1997). In theory, the LMU
was similarly demanding, requiring convergence to a common standard and limiting the emission of undervalued silver coins or paper money. In practice, LMU members sometimes skirted these conditions, exited a metallic standard entirely, or eventually returned to gold. In comparing empirical results on the LMU to those on the gold standard, we seek to measure the significance of the adoption of the LMU and its perceived and actual credibility relative to a gold standard. Put another way, did membership of the LMU imply the same degree of monetary stability and credibility as explicitly adopting the gold standard directly?
We begin by examining the volatility of financial and economic indicators across time periods of different monetary regimes:
H1. The volatility of interest rates, bond yields, inflation, and trade is lower when a country is a member of the LMU.
H2. The volatility of interest rates, bond yields, inflation, and trade is lower when a country is on the gold standard.
H1 suggests that membership of the LMU contributes to economic stability and is associated with lower volatility, even if member countries violated the spirit of LMU or even adopted paper money at points. H2 predicts that adoption of the gold standard can serve a similar purpose.
In a related manner, we test whether adoption of a particular monetary system (LMU or gold) implies convergence to the economic indicators of the leading proponent of that system:
H3. Interest rates, bond yields, inflation rates, and trade of LMU members (or others who mimic LMU standards) are more highly correlated with those of the dominant LMU member, France, when they are both LMU members.
H4. Interest rates, bond yields, inflation rates, and trade of a particular country are more highly correlated with those of the U.K. when the particular country is on the gold standard.
Again, we benchmark the significance of the LMU by comparing it to the significance, in terms of economic convergence, of the gold standard as upheld by Great Britain throughout our sample period.
Next, we transform our inflation and exchange rate data in a useful manner for an additional volatility test:
H5. Purchasing Power Parity deviations decline during periods when a country is (formally or informally) an LMU member.
H6. Purchasing Power Parity deviations decline during periods when a country is on gold.
For those countries, time periods, and frequencies for which we have inflation data, we compute the average PPP deviation within sub periods and test whether the average deviation is significantly different during the period a particular country was in the LMU, or on gold. Again, the varying degrees to which member states followed the LMU suggest looking at individual countries. PPP deviations are computed against the French franc or British pound.
Finally, we follow previous authors (see, for example, Bordo and Rockoff, 1996) and study the spread of a country's bond yield over the British bond yield as a measure of credibility:
H7. The spread of a country's bond yield over gold standard leader Great Britain declines when the country adopts the gold standard.
H8. The spread of a country's bond yield over gold standard leader Great Britain declines when the country is a member of the LMU.
3.2. Data
The LMU was agreed to in December 1865. Our starting point is 1822, by which time the U.K. had fully adopted the gold standard. We terminate the sample at June 1914, the time of the outbreak of the First World War when more fundamental economic and military considerations were at work. Our principal source of data is the Global Financial Database (www.globalfinancialdata.com/index.html), which is available by subscription. We also employ a few series previously collected by Bailey and Bhaopichitr (2004) and Bailey et al. (2003). Throughout the tables of results, we organize the countries into four sets: founding LMU members (France, Belgium, Italy, Switzerland), principal non-LMU European countries that typically maintained a gold standard (Germany, Netherlands, U.K.), other European countries (Austria-Hungary, Denmark, Finland, Greece, Portugal, Russia, Spain, Sweden, Turkey), and non-European countries (Canada, India, South Africa, U.S.A.).
Table 2 summarizes the data series that are available for the countries of interest identified in Table 1. The quality of data varies widely across sample countries, frequencies, and types of information. France has generally good monthly data for private bill rates and bond yields, although there are large runs of missing bond yields, private bill yields begin only in 1860, and the consumer price index is annual. Among other LMU founders, Belgium has fewer available bond yields than France while Italy and Switzerland have little or no bond or interest rate information. A later LMU entrant that experienced difficulties, Greece, has only scraps of bond yield data. At the other extreme, Great Britain has excellent coverage of all data series. The U.S. has fairly good data as well, but its usefulness is compromised since the use of depreciated currency during and after the Civil War makes the U.S. much less suitable than Britain as a benchmark for other countries. Wherever possible, we splice related series together to maximize the time series and cross section of available data. For example, dollar exchange rates are translated to pounds to fill in any gaps in pound exchange rates, Berlin private bill yields replace the Hamburg yields that end in 1899, and wholesale price inflation stands in for any unavailable consumer price inflation.
Our empirical results suffer the potentially confounding impact of contemporaneous events. For example, the Franco Prussian War (14 July 1870 to 10 May 1871) drove France to inconvertible paper money and put a large war indemnity in Prussia's hands at war's end. The "Panic of 1873" and other crises affected economies around the globe. Regional tensions
and wars involving Italy, Austria-Hungary, and other European countries were also at work during the period we study. Furthermore, the ultimate ambiguity in this study is the degree to which the LMU was an ideal rather than an actual monetary system. Adherence to LMU rules by LMU members (or those states paralleling LMU) was often uneven. This is clear from our discussion in Section 2. Italy and others sometimes violated the spirit of the Union by overproducing cheap silver coins or small denomination paper money. Therefore, we must treat each country or pair of countries individually in estimating and interpreting empirical results.
To compare the behavior of economic and financial indicators under the LMU to their behavior in the modern European monetary system, we also collected three-month interbank interest rates, 10-year government bond yields, inflation, and industrial production growth from Datastream for the 15 members of the European Union. The data are monthly and span the period from January 1979 to December 2000. The sample of 15 countries includes four (Denmark, Greece, Sweden, and the U.K.) that, as of the end of 2000, were not members of the new common currency, the euro.
4. Results
4.1. Volatility over LMU and gold standard time periods
Table 3 summarizes the difference-in-means tests for squared values of private bill yields, bond yields, inflation, and trade across LMU, gold standard, and other time periods. In Panel A, there is substantial, though less than perfect, evidence that France, Belgium, and most other countries that followed relatively responsible policies experienced decreases in the volatility of money market interest rates and bond yields during periods spent on the gold standard, H2. On the other hand, there is only mixed evidence that the most egregious violator of LMU rules and good monetary practices, Italy, experienced change in the volatility of these indicators while on the gold standard. Across all countries, the evidence on inflation and trade is typically weaker, perhaps because of the short series of only annual data that are available.
Table 3 also breaks the data in "LMU" and "non LMU" periods, in addition to "gold" and "not gold" periods as discussed previously. In Panel B, there are fewer countries with which to study the "on LMU" slope dummy, and this is aggravated by lack of data on some series for some time periods. The results indicate less volatility in bond yields for core LMU members, France and Belgium, during periods when they are in the LMU, thus supporting hypothesis H1. There is also evidence that joining or following the LMU reduced bond yield volatility for two countries, Greece and Spain, with a more volatile economic record. Again, much weaker results for annual inflation and trade may be the result of small time series of data. Thus, mere LMU membership may have reassured the bond markets that good policies were in place or would be adhered to soon. On the other hand, there is no evidence that LMU membership, as was the case for adoption of a gold standard, lowered the volatility of Italian bond yields.
Table 2
Summary of data.
Monthly exchange rate Monthly exchange Monthly government bond yield Monthly private bill Annual Wholesale Annual Consumer Annual imports
with pound rate with U.S. dollar yield (3 months) Price Index Price Index and exports
France All All 7/1822 to 3/1833, 3/1844 to 5/1846, 10/1847 on [957] 8/1860 on [648] 1840 on [74] All
Belgium 1/1830 on [1015] 6/1832 to 1/1859, 1/1885 to 12/1897, 1/1911 on [518] 7/1848 on [793] 1835 on [79] 1846 on [68]
Italy Thru 12/1899 All 3/1863 on [616] 1861 on [53] 1861 on [53]
Switzerland All All
Germany H: thru 2/1873 H: thru 12/1872
7/1872 on 7/1822 to 3/1826, 1/1870 on [579] H: 1/1854 to 12/1899 spliced to B: 1/1900 on [726] All All
Netherlands All All 10/1831 to 6/1870, 4/1873 to 12/1873, 1/1875 to 3/1880, 8/1882 on [920] 7/1860 on [649] 1846 on [68]
United Kingdom All All All All All All
Austria-Hungary thru 12/1899 All 7/1860 on [649] 1831 on [83]
Denmark 1/1864 on [607] 7/1822 to 9/1858, 1/1878 on [872] All 1841 on [73]
Finland 4/1860 on [652] All
Greece 3/1863 to 5/1880,2/1881 on [608]
Portugal All All 11/1823 to 12/1902, 1/1904 on [1075] 1865 on [49]
Russia thru 12/1899 All 9/1822 on [1102] All
Spain All All 8/1822 on [1103] All All
Sweden All 1860 on [54] 1830 on [84] 1832 on [82]
Turkey 1/1826 on [1063] 4/1855 on [711]
Canada 1/1858 on [679] 8/1855 on [707] All 1832 on [82]
India 7/1822 on [1105] All 1832 on [82]
South Africa 1/1844 on [835] 12/1860 on [643] 1826 on [88]
U.S.A. All 1/1849 to 12/1857, 1/1861 on [750] 12/1835 on [944] All All All
This table summarizes the span of our data. The starting point is January 1822 and the ending point is June 1914 for monthly bond and bill data and 1914 for annual inflation and trade data, yielding maximum possible observations of 1110 and 93 respectively. "All" indicates that the particular series spans the entire period. For Germany, "H" indicates Hamburg and "B" Berlin. Number in square brackets indicates approximate number of observations for those series that are neither complete nor empty. A few irregular missing values also occur for some series, as is evident in the number of observations reported for subsequent tests.
Table 3
Volatility over LMU, gold standard, and other time periods.
Private bill yields
Bond yields
Inflation
Imports plus exports
Average square
Average square
Average square
Average square
Panel A: comparing gold standard and non gold standard periods
France
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Not on gold On gold i-Test
Panel B: comparing LMU and non
Belgium
Greece
Finland
Sweden
Denmark
Germany
Austria
Netherlands
Portugal
207 439
292 499
France
Belgium
Greece
Finland
Not in LMU In LMU i-Test
Not in LMU In LMU i-Test
Not in LMU In LMU i-Test
Not in LMU In LMU i-Test
Not in LMU In LMU i-Test
Not in LMU In LMU i-Test
0.291 0.178 2.110 0.257 0.176 1.180
215 510
385 262
159 488
768 172
LMU periods 63 583
208 583
0.892 0.343 4.480 0.171 0.096 2.670
0.410 0.117 5.380
3.459 0.308 2.280
0.384 0.196 2.250 0.119 0.236 1.560
515 439
319 196
491 124
499 107
433 437
67 510
856 253
470 440
592 482
576 172
371 583
319 196
32 583
69 537
437 433
0.067 0.002 2.600 0.012 0.002 43.660 0.082 0.009 1.660 1.596 8.148 -6.150
0.018 0.001 5.450 0.031 0.000 1.760
0.006 0.001 3.850 0.026 0.002 3.140 0.391 0.680 -0.690 0.011 0.001 2.460
0.087 0.005 2.370 0.012 0.002 3.660 0.016 0.070 -2.84 8.654 1.995 5.160 0.018 0.001 5.450
5.915 2.332 1.960 33.131 23.196 0.850 40.478 8.258 1.450
19.709 18.251 0.200 38.629 15.521 2.340 156.530 19.333 3.190
38.293 7.301 1.580
6.556 2.883 1.900
38.393
21.394 1.420
27.752 34.283 -0.190
127.940 37.430 2.110 174.310 151.090 0.230 63.790 90.010 0.650
244.510 106.890 1.840 209.590 80.220 2.300 294.730 53.870 2.510
170.900 35.590 0.960 115.440 65.120 1.210 54.380 32.650 1.400 49.800 66.500 -0.800 274.820 59.250 1.280
151.680 38.790 2.730 182.400 151.270 0.770 36.650 71.520 0.580
260.760 114.560 2.000 197.150 81.406 1.840
This table summarizes the difference-in-means tests for squared values of interest rates, bond yields, inflation, and trade across LMU, gold standard, and other time periods. Interest rates are monthly first differences of short maturity private bill yields, bond yields are monthly first differences of government bond yields, inflation is annual log difference of consumer or producer price indexes, and imports plus exports is the annual log differences of the sum of those two indicators. Maximum time period is 1822 to June 1914, with data availability indicated in Table 2.
4.2. Correlation with French and British indicators
Table 4 summarizes the results of regressions that relate interest rates (Panel A), bond yields (Panel B), inflation rates (Panel C), and trade (Panel D) to the LMU leader, France (H3). Regressions include slope dummy terms to identify changes in the relationship when the particular country is on the gold standard or in the LMU:
Zi,t,t+1 = a + ^ZFrance,M+1 + P (DLMU,i,t,t+1 X ZFrance,t,t+1) +P(Dgold,i,t,t+1 X Zf rance,t, t+1) + £i,t,t+1 (1)
Zi,t,t+1 represents the change in economic or financial indicator Z for country i from t to t +1, ZFrance,t,t+i represents the contemporaneous change in the indicator for France, DLMU,i,t,t+1 is a dummy variable that takes the value one when country i follows the LMU from t to t +1, Dgold,i,t,t+1 and is a dummy variable that takes the value one when both country i and France are on a gold standard. The dummy variables define slope dummy terms that allow us to observe changes in the relationship over different monetary regimes. The other symbols represent the estimated intercept, slopes, and errors.
In Panel A, there is evidence of strong correlation between private bill yields of European states and those of France. This suggests some degree of commonality or integration across European money markets. However, many insignificant slopes on the gold and LMU slope dummy terms indicate no evidence that adoption of gold or membership of the LMU induced convergence towards French money market prices. Furthermore, negative slopes (Belgium, Netherlands, Great Britain) suggest less convergence with France during common gold standard periods.
Panel B presents similar evidence for bond yields. The slope coefficients on the French bond yield indicate strong commonalities between French bond yields and those of other states, even economies like Italy, Greece, Turkey, and Russia that experienced economic and monetary policy turmoil at several points during our sample period. However, estimated coefficients on gold and LMU slope dummy terms again indicate little convergence to the pricing of France's bonds with gold or LMU membership. The negative slope for Greece on the LMU slope dummy term suggests that Greek bond pricing become more idiosyncratic once Greece joined the LMU.
Panel C presents similar evidence on inflation rates as they relate to French inflation. Again, there is evidence in the slope coefficients of common factors across many of our sample countries. At the same time, Italy's relatively low R2 are consistent with the chaotic Italian fiscal and monetary policies contributing to detaching Italian inflation from French trends during this period.
Panel D presents similar evidence on rates of growth of trade (imports plus exports) as they relate to corresponding rates for France. Given the lack of GDP or industrial production data for our sample countries during this early time period, the trade numbers may be thought of as proxies for real activity, in addition
to being of interest in and of themselves.3 Again, there is evidence in the slope coefficients of commonalities between France and many countries. At the same time, there is no evidence that correlation was heightened when the country and France were both members of the LMU or both on gold.
Table 5 summarizes the results of regressions that relate interest rates (Panel A), bond yields (Panel B), inflation rates (Panel C), and trade (Panel D) to gold standard Great Britain. The specification is similar to that used in Table 4, that is, Eq. (1). Our hypothesis, H4, is that the adoption of gold (rather than the LMU) was critical in binding a particular country to the economic conditions of the standard-bearer of that monetary system.
In Panel A, there is evidence that, except for the U.S., there is a strong relationship between U.K. interest and those of other economies. Note, however, that the absence of data for Italy and other problematic non-LMU members like Russia and Turkey limits this conclusion. Furthermore, there is little evidence among the estimated coefficients on slope dummy terms that adoption of the gold standard (or membership of the LMU) made any difference in converging interest rates to those of the U.K. Indeed, negative slopes for France and Germany suggest lower correlation with gold standard U.K. during gold or LMU periods.
Panel B presents similar evidence on bond yields: there is much evidence of correlation with U.K. bond yields but little evidence that the correlation tightened when a particular country shared Britain's gold standard. The positive slope for Greece on the gold slope dummy indicates greater correlation with the U.K. when both are on gold while the negative slope for Greece on the LMU slope dummy indicates less correlation, as do negative coefficients on the gold slope dummy for France, Denmark, India, and the Netherlands.
Panel C mirrors what we report earlier for convergence on French indicators. There is generally strong correlation between national inflation rates and U.K. inflation, but no impact of monetary regime slope dummy terms. Again, it is notable that the correlation is relatively low for Italy, suggesting much volatility and turmoil in the economic conditions and policies of this LMU member. Collectively, the evidence indicates that LMU membership did not hasten convergence to the economic conditions of the leading member. However, there is no evidence that the gold standard had any more power to converge economic conditions to those of the U.K.
Panel D roughly mirrors what was reported for correlations with France's trade in Panel D of Table 4. There is much evidence of strong links between the trade of our sample countries and trade of gold standard leader Great Britain, but little evidence that the links tightened when a particular country adopted the gold standard.
3 Bailey and Bhaopichitr (2004), for example, use the rate of change of the sum of imports and exports to proxy for economic activity in their study of Pacific Rim capital markets and monetary regimes in the period from 1870 to 1939.
Table 4
Regressions relating interest rates, bond yields, inflation, and trade to those of France.
Nobs Constant Slope on France Slope on France x gold dummy Slope on France x LMU dummy Adjusted R2
Panel A: Private bill yields
Belgium 646 -0.002 -0.087 0.224 5.443 0.044
U.S. 644 -0.015 -0.321 0.175 1.743 0.005
Austria 646 -0.002 -0.105 0.178 5.710 0.048
Germany 646 0.002 0.092 0.508 9.355 0.120
Netherlands 646 -0.002 -0.097 0.181 5.022 0.038
U.K. 646 -0.002 -0.068 0.410 7.356 0.078
Belgium 646 -0.001 -0.064 0.411 6.647 -0.330 -4.013 0.067
U.S. 644 -0.015 -0.318 0.149 1.355 0.154 0.573 0.005
Austria 646 -0.002 -0.112 0.166 4.464 0.039 0.576 0.049
Germany 646 0.003 0.103 0.616 7.486 -0.191 -1.741 0.124
Netherlands 646 -0.001 -0.076 0.329 6.087 -0.262 -3.651 0.057
U.K. 646 -0.001 -0.045 0.650 7.780 -0.426 -3.830 0.098
Belgium 646 -0.002 -0.110 0.379 3.855 -0.188 -1.734 0.048
Panel B: bond yields
Belgium 366 -0.002 -0.500 0.048 2.619 0.019
Italy 615 -0.004 -0.413 1.446 10.071 0.142
Greece 606 0.010 0.149 5.304 5.457 0.047
Spain 953 0.012 0.258 0.304 1.215 0.002
Canada 706 -0.002 -0.782 0.033 0.772 0.001
Denmark 721 -0.001 -0.247 0.091 5.081 0.035
Germany 577 -0.001 -0.453 0.067 2.022 0.007
India 954 0.000 0.048 0.047 4.121 0.018
Netherlands 767 -0.001 -0.272 0.205 9.643 0.108
Portugal 925 -0.010 -0.420 0.203 1.599 0.003
South Africa 642 -0.001 -0.311 0.151 4.470 0.030
U.S. 748 -0.003 -0.984 0.054 1.437 0.003
Turkey 710 -0.004 -0.217 1.779 7.411 0.072
Russia 606 0.010 0.149 5.304 5.457 0.047
U.K. 954 0.000 -0.363 0.063 8.936 0.077
Belgium 366 -0.002 -0.484 0.047 2.555 0.071 0.419 0.019
Italy 615 -0.005 -0.496 1.509 10.033 -0.699 -1.393 0.145
Denmark 721 -0.001 -0.263 0.093 5.137 -0.095 -0.766 0.035
Germany 577 -0.001 -0.451 0.066 1.781 0.006 0.072 0.007
India 954 0.000 0.061 0.047 4.134 -0.051 -0.346 0.018
Netherlands 767 -0.001 -0.278 0.206 9.572 -0.037 -0.247 0.108
Portugal 925 -0.009 -0.368 0.171 1.338 2.025 1.994 0.007
U.S. 748 -0.003 -0.944 0.057 1.506 -0.126 -0.541 0.003
U.K. 954 0.000 -0.339 0.062 8.698 0.054 1.064 0.078
Belgium 366 -0.002 -0.484 0.047 2.555 0.071 0.419 0.019
Italy 615 -0.004 -0.407 0.911 0.968 0.548 0.575 0.142
Greece 606 0.008 0.129 11.695 5.356 -7.939 -3.262 0.064
Spain 953 0.013 0.271 0.229 0.884 1.194 1.161 0.003
Panel C: inflation
Belgium 74 -0.351 -0.608 1.068 3.754 0.164
Italy 53 0.462 0.562 -0.382 -0.785 0.012
Sweden 74 0.292 0.557 0.604 2.343 0.071
Denmark 74 0.034 0.067 0.992 3.997 0.182
Germany 74 0.735 0.721 1.603 3.192 0.124
U.S. 74 0.586 0.966 0.465 1.555 0.033
U.K. 74 -0.546 -0.942 1.202 4.214 0.198
Belgium 74 -0.360 -0.618 1.146 3.397 -0.271 -0.433 0.166
Italy 53 0.449 0.538 -0.343 -0.592 -0.144 -0.131 0.012
Sweden 74 0.278 0.529 0.734 2.412 -0.457 -0.811 0.079
Denmark 74 0.020 0.039 1.127 3.847 -0.472 -0.870 0.190
Germany 74 0.712 0.696 1.826 3.076 -0.781 -0.711 0.130
U.S. 74 0.595 0.968 0.480 1.489 -0.112 -0.132 0.033
U.K. 74 -0.563 -0.971 1.368 4.068 -0.583 -0.936 0.208
Table 4 (Continued)
Nobs Constant Slope on France Slope on France X gold dummy Slope on France X LMU dummy Adjusted R2
Belgium 74 -0.358 -0.619 1.289 3.337 -0.476 - 0.848 0.172
Italy 53 0.624 0.754 -2.736 -1.411 2.492 1.253 0.042
Panel D: imports plus exports
Belgium 67 2.792 2.066 0.606 4.406 0.230
Italy 52 1.297 1.299 0.701 4.481 0.286
Finland 91 3.094 2.300 0.540 3.852 0.143
Spain 91 1.587 1.180 0.425 3.034 0.094
Canada 46 3.169 2.137 0.764 3.258 0.194
Sweden 81 2.776 2.265 0.518 4.032 0.171
Denmark 72 2.653 1.903 0.513 3.522 0.151
Austria 82 0.971 0.939 0.768 7.220 0.395
India 81 3.867 3.575 0.171 1.508 0.028
Netherlands 67 4.725 8.421 0.025 0.430 0.003
Portugal 48 1.500 1.332 0.299 1.655 0.056
South Africa 83 5.678 2.616 0.259 1.153 0.016
Russia 91 1.813 1.106 0.536 3.142 0.100
U.S. 91 2.987 1.762 0.213 1.206 0.016
U.K. 91 1.371 1.635 0.515 5.891 0.281
Belgium 67 2.627 1.928 0.546 3.628 0.311 0.964 0.241
Italy 52 0.821 0.819 0.838 4.999 -0.848 1.952 0.338
Finland 91 2.978 2.200 0.493 3.281 0.319 0.881 0.150
Canada 46 3.114 2.086 0.504 1.161 0.359 0.714 0.204
Sweden 81 2.727 2.204 0.496 3.553 0.129 0.409 0.172
Denmark 72 2.632 1.862 0.504 3.142 0.046 0.134 0.151
Austria 82 1.103 1.054 0.797 7.169 -0.276 0.902 0.401
India 81 3.643 3.312 0.136 1.156 0.359 1.080 0.042
Netherlands 67 4.720 8.281 0.023 0.360 0.010 0.073 0.003
Portugal 48 1.460 1.293 0.225 1.131 0.387 0.899 0.073
U.S. 91 2.859 1.668 0.186 1.015 0.357 0.605 0.020
U.K. 91 1.316 1.557 0.492 5.251 0.150 0.665 0.284
Belgium 67 2.557 1.888 0.502 3.202 0.388 1.349 0.251
Italy 52 1.402 1.390 0.354 0.819 0.387 0.861 0.297
Finland 91 2.978 2.200 0.493 3.281 0.319 0.881 0.150
Spain 91 1.489 1.103 0.363 2.340 0.303 0.944 0.103
Interest rates are first differences of short maturity private bill yields, bond yields are first differences of government bond yields, inflation is the log difference of consumer or producer price indexes, and imports plus exports is the log difference of the sum of imports and exports in local currency. Maximum time period is 1822 to June 1914 with data availability indicated in Table 2. Some specifications include slope dummy terms to isolate periods when both the country and France were following the LMU or the gold standard. t statistics are reported to the right of each estimated coefficient. In some cases, regressions with regime slope dummy terms could not be estimated because the country did not change standards, changes in standards were too ambiguous to quantify, or the country's data are incomplete and, therefore, do not span more than one regime.
4.3. Adherence to Purchasing Power Parity during LMU and gold periods
Table 6 summarizes the difference-in-means tests for the average deviation from Purchasing Power Parity (PPP) and average squared values of that deviation across LMU, gold standard, and other time periods. The PPP deviation is measured as the rate of change of the franc or pound value of a particular country minus the difference between the particular country's inflation and franc or pound inflation.
The center column of the table indicates that, on average, PPP deviations were small and did not differ across monetary systems. However, the right-hand column of the table indicates that the volatility of PPP deviations was often significantly or marginally significantly lower as an LMU member or on the gold standard. Interestingly, LMU membership seems more sig-
nificant than a gold standard in reducing fluctuations in PPP deviations for key LMU member states France and Belgium. Once again, Italy deviates from the behavior of other countries: squared PPP deviations appear larger during the LMU period, although the number of non LMU data points available for study is extremely limited. The results confirm earlier findings and our hypotheses H5 and H6: the choice of monetary regime appears to be associated with the volatility of economic and financial indicators and, in particular, adherence to some sort of standard appears to reduce that volatility.
4.4. Bond yields and the credibility of a monetary standard
Table 7 reports the results of regressions of country bond spreads on monetary regime dummy variables and an average bond spread. Each country's bond spread equals the yield
Table 5
Regressions relating interest rates, bond yields, inflation, and trade to those of Great Britain.
Nobs Constant Slope on U.K. Slope on U.K. x gold dummy Slope on U.K. x LMU dummy Adjusted R2
Panel A: private bill yields
France 646 0.000 -0.003 0.268 7.310 -0.153 -2.991 0.090
Belgium 791 -0.004 -0.243 0.130 3.825 0.018 0.386 0.045
U.S. 940 -0.013 -0.234 0.075 0.854 0.261 1.014 0.003
Austria 647 -0.002 -0.107 0.048 1.934 0.105 2.166 0.026
Germany 725 0.002 0.079 0.493 9.354 -0.313 -4.459 0.125
Netherlands 647 0.001 0.034 0.097 2.371 -0.055 -1.068 0.011
France 646 -0.001 -0.054 0.389 6.174 -0.092 -1.605 -0.183 -2.363 0.098
Belgium 791 -0.003 -0.208 0.047 1.169 -0.187 -2.673 0.287 3.879 0.063
Panel B: bond yields
France 954 -0.001 -0.222 1.231 8.936 0.077
Belgium 515 -0.002 -0.524 0.358 3.575 0.024
Italy 615 -0.006 -0.578 1.354 3.932 0.025
Greece 606 0.001 0.014 10.136 4.596 0.034
Spain 1102 -0.001 -0.030 4.981 4.935 0.022
Canada 706 -0.003 -0.815 0.360 3.709 0.019
Denmark 870 -0.001 -0.266 0.778 11.490 0.132
Germany 576 -0.001 -0.581 0.450 6.841 0.075
India 1109 0.000 -0.203 0.639 14.503 0.160
Netherlands 916 -0.002 -0.463 0.924 9.140 0.084
Portugal 1074 0.000 -0.012 1.787 3.324 0.010
South Africa 642 -0.001 -0.425 0.309 4.151 0.026
U.S. 748 -0.004 -1.048 -0.003 -0.029 0.000
Turkey 710 -0.006 -0.316 1.602 2.808 0.011
Russia 606 0.001 0.014 10.136 4.596 0.034
France 954 -0.001 -0.126 1.558 9.954 -1.368 -4.270 0.095
Belgium 515 -0.002 -0.528 0.368 3.285 -0.048 -0.192 0.024
Italy 615 -0.006 -0.600 1.467 3.852 -0.623 -0.698 0.025
Greece 606 0.008 0.120 7.222 3.124 26.510 3.800 0.056
Denmark 870 0.000 -0.160 0.994 13.063 -0.912 -5.828 0.165
Germany 576 -0.001 -0.581 0.874 9.139 -0.766 -5.956 0.129
India 1109 0.000 -0.016 0.728 15.385 -0.593 -4.852 0.177
Netherlands 916 -0.002 -0.401 1.218 9.935 -0.886 -4.164 0.101
Portugal 1074 0.000 -0.012 1.795 2.798 -0.028 -0.024 0.010
U.S. 748 -0.004 -1.047 -0.005 -0.043 0.007 0.033 0.000
France 954 -0.001 -0.138 1.582 9.747 -1.044 -1.594 -0.349 -0.569 0.095
Italy 615 -0.006 -0.593 1.094 0.779 -0.652 -0.725 0.403 0.276 0.026
Greece 606 0.009 0.143 32.376 5.329 30.622 4.418 -29.263 -4.466 0.087
Panel C: inflation
France 74 0.386 1.831 0.188 4.035 -0.079 -0.913 0.207
Belgium 79 0.055 0.111 0.549 4.918 0.026 0.130 0.327
Italy 53 0.399 0.504 0.422 1.952 -0.427 -1.116 0.071
Sweden 84 0.577 1.365 0.333 3.699 0.134 0.787 0.231
Germany 92 1.125 1.195 0.650 3.436 -0.189 -0.500 0.134
U.S. 92 0.485 0.799 0.235 2.240 0.088 0.144 0.056
France 74 0.377 1.779 0.171 3.371 -0.168 -1.210 0.105 0.822 0.215
Belgium 79 0.042 0.084 0.540 4.624 -0.086 -0.199 0.121 0.289 0.328
Italy 53 0.424 0.534 0.725 1.668 -0.326 -0.809 -0.403 -0.804 0.083
Panel D: imports plus exports
France 91 1.575 1.832 0.545 5.891 0.281
Belgium 67 2.428 1.694 0.708 3.938 0.193
Italy 52 2.105 1.785 0.345 1.729 0.056
Finland 91 3.867 2.736 0.320 2.103 0.047
Spain 91 0.763 0.629 0.725 5.548 0.257
Canada 46 2.417 1.645 1.035 3.921 0.259
Sweden 81 2.181 1.835 0.709 5.048 0.244
Denmark 72 2.162 1.529 0.676 3.799 0.171
Austria 82 1.983 1.617 0.548 3.790 0.152
Table 5 (Continued)
Nobs Constant Slope on U.K. Slope on U.K. x gold dummy Slope on U.K. x LMU dummy Adjusted R2
India 81 3.891 3.527 0.167 1.281 0.020
Netherlands 67 4.637 7.997 0.051 0.704 0.008
Portugal 48 1.146 1.008 0.427 2.147 0.091
South Africa 83 4.934 2.284 0.514 2.025 0.048
Russia 91 1.535 0.964 0.663 3.868 0.144
U.S. 91 0.876 0.609 0.923 5.958 0.285
France 91 1.477 1.701 0.517 5.256 0.215 0.863 0.287
Belgium 67 2.421 1.673 0.700 3.389 0.028 0.077 0.193
Italy 52 1.786 1.509 0.471 2.205 -0.840 -1.524 0.099
Finland 91 3.399 2.460 0.185 1.181 1.023 2.584 0.115
Sweden 81 2.064 1.744 0.621 4.067 0.454 1.426 0.263
Denmark 72 2.108 1.482 0.613 3.035 0.249 0.666 0.176
Austria 82 2.021 1.610 0.555 3.676 - 0.070 -0.164 0.153
India 81 3.633 3.225 0.130 0.970 0.419 1.092 0.035
Netherlands 67 4.633 7.919 0.046 0.545 0.021 0.140 0.008
Portugal 48 1.179 1.027 0.322 1.045 0.170 0.451 0.095
U.S. 91 0.846 0.579 0.919 5.776 0.085 0.141 0.285
France 91 1.463 1.673 0.515 5.115 0.171 0.766 0.285
Belgium 67 2.360 1.624 0.662 3.067 0.133 0.386 0.194
Italy 52 2.105 1.763 0.348 0.694 -0.003 -0.006 0.056
Finland 91 3.399 2.460 0.185 1.181 1.023 2.584 0.115
Spain 91 0.488 0.400 0.652 4.673 0.458 1.410 0.273
Interest rates are first differences of short maturity private bill yields, bond yields are first differences of government bond yields, inflation is the log difference of consumer or producer price indexes, and imports plus exports is the log difference of the sum of imports and exports in local currency. Maximum time period is 1822 to June 1914 with data availability indicated in Table 2. Specifications include slope dummy terms to isolate periods when the country was following the LMU or on the gold standard. t-Statistics are reported to the right of each coefficient estimate. In some cases, regressions with regime slope dummy terms could not be estimated because the country did not change standards, changes in standards were too ambiguous to quantify, or the country's data are incomplete and, therefore, do not span more than one regime. Great Britain was on the gold standard throughout this time period.
on the country's bond minus the yield on the comparable British bond. The average bond spread is a cross sectional average of such spreads across all countries. It is intended to pick up market-wide movements in bond spreads (Bordo and Rockoff, 1996). The two panels of Fig. 2 plot bond yield spread series for selected sample countries. The size and variability of spreads is particularly evident for Italy, Greece, and Spain.
In Panel A of the table, credibility under a gold standard, H7, is examined. Most countries display strongly statistically significant negative slopes for the gold regime dummy. This indicates that, on a gold standard, bond yields in these countries became closer to yields on Great Britain's debt. Once again, however, Italy stands out: after controlling for the average market-wide spread, Italian yield spreads seem to increase when the country is on gold, implying declining credibility.
Panel B tests for the credibility during membership of the LMU, H8. We employ a more complex set of dummy variables to isolate periods when the particular country was a member of the LMU but there was no concurrent gold standard. It appears that France's bond spreads were lower under concurrent LMU and gold standards but higher while an LMU member but not on gold. This is sensible. The measure of "credibility under LMU" actually implies greater credibility for Italy on an "LMU plus paper money" system. Again, the complex situation of Italy is evident.
5. Does history repeat itself?
A primary driving factor in the failure of the LMU was the performance of Italy's government. Budget deficits and government borrowing were not kept under control while issuance of subsidiary silver coin and small denomination paper money imposed costs on other Union members. Similar problems arose under the pre Euro arrangements in Europe when the fiscal deficits and money growth of weaker members were "exported" to Germany and other stronger economies through the managed exchange rate system that prevailed at the time.
Is this likely to happen again? Euro-area countries have no power to create additional money and, furthermore, they must adhere to constraints on budget deficits and other macro indicators. Thus, the powers that Italy used to undermine the LMU to her own benefit are not available to Euro-area countries. However, the conditions under which a member state might be "warned" or penalized for violating fiscal deficit strictures remain an issue and it is conceivable that a member in trouble may put itself at risk of leaving or being ejected from the euro area.
There are precedents, such as the case of Argentina exiting its currency board, for hard currency standards being abandoned in times of economic turmoil. Furthermore, fiscal problems in France and Germany were among the first events to threaten the convergence criteria established for euro-area membership.
Table 6
Purchasing Power Parity deviations over LMU, gold standard, and other time periods.
Nobs Average PPP deviation Average
France Not on gold 37 -0.54 31.96
On gold 37 -0.40 16.75
t-Test -0.12 1.69
Belgium Not on gold 37 0.45 33.00
On gold 42 0.00 20.75
t-Test 0.38 1.51
Italy Not on gold 28 -0.21 79.94
On gold 10 -3.36 35.37
t-Test 1.33 1.70
Sweden Not on gold 43 0.10 39.99
On gold 41 -0.74 19.97
t-Test 0.71 2.09
Denmark Not on gold 9 0.52 16.70
On gold 41 -0.45 18.48
t-Test 0.62 -0.22
Germany Not on gold 49 -0.85 144.84
On gold 2 -3.49 27.69
t-Test 0.30 2.61
U.S. Not on gold 78 -0.09 49.79
On gold 14 -0.58 7.63
t-Test 0.25 5.10
France Not in LMU 25 -0.82 39.48
In LMU 49 -0.29 16.64
t-Test -0.38 1.97
Belgium Not in LMU 30 0.14 37.83
In LMU 49 0.25 19.55
t-Test -0.08 2.16
Italy Not in LMU 4 1.29 7.30
In LMU 34 -1.32 75.37
t-Test 1.29 -3.60
This table summarizes the difference-in-means tests for the average value of annual deviations from Purchasing Power Parity (PPP) and for squared values of that deviation across LMU, gold standard, and other time periods. The PPP deviation is measured as the rate of change of the franc or pound value of a particular country minus the difference between the particular country's inflation and franc or pound inflation. Maximum time period is 1822 to June 1914 with data availability indicated in Table 2.
To look at the impact of the evolution of the European monetary system and subsequent European Monetary Union, we relate interest rates, government bond yields, inflation rates, and industrial production growth of 14 European Union states to those of core EMS/EMU member, Germany. The monthly data span the period from January 1979 to December 2000, and the regressions include slope dummy terms to identify the period of convergence (from the February 1992 signing of the Maastricht Treaty to the month before approval of the Euro Plan in May 1998) and the period of monetary union (from May 1998 to the present). Note that, as of December 2000, four EU states, Denmark, Greece, Sweden, and the United Kingdom, had not adopted the euro.
Table 8 presents the results in a format similar to Tables 4 and 5. In Panel A of Table 8, changes in three-month interbank rates are related to changes in three-month German interbank rates and slope dummy terms. There is evidence of significant correlation between interbank interest rate changes in Germany and in a few other euro members (Austria, Belgium, France, Netherlands) and one non-member (Sweden). There is little evidence that this correlation tightens during specific peri-
ods in the development of the EMS/EMU, and some evidence that it weakens.
In Panel B of Table 8, changes in 10-year government bond rates are related to changes in 10-year German government bond yields. In contrast to the results on short term interest rates in Panel A, the slope coefficient estimates indicate a strong correlation with German bond yields regardless of the state of the EMS/EMU for most EU countries whether they adopt the euro or not. Interestingly, some of the strongest correlations exist for those economies that have not adopted the euro. Strong positive slopes on the (199202-199804) slope dummy term for many economies indicates that the convergence to German bond yields strengthened with the Maastricht Treaty and the expectation that EU states would converge their economic and financial conditions as a prelude to monetary union. Several countries also display a strong positive slope on the (199805-200012) slope dummy term, indicating still stronger convergence with the formal approval of the Euro Plan.
A number of other interesting results are evident in the table. First, the Netherlands shows no significance on the slope dummy
Table 7
Regressions to assess gold standard and LMU credibility using spreads of bond yields over British bond yields.
Nobs Constant Slope on gold dummy Slope on average bond yield spread Adjusted R2
Pasel A: gold stasdard credibility
France 957 1.291 57.973 -0.901 -27.387 0.440
Belgium 518 1.460 81.930 -1.130 -39.207 0.749
Italy 616 2.864 34.466 -0.548 -2.960 0.014
Denmark 872 1.002 50.160 -0.135 -4.780 0.026
Germany 579 1.373 67.428 -0.548 -23.450 0.488
India 1110 0.922 77.591 -0.330 -13.260 0.137
Netherlands 920 1.122 70.070 -0.764 -31.879 0.525
Portugal 1075 3.505 44.309 -1.071 -5.851 0.031
U.S. 750 1.418 43.959 -1.205 -17.881 0.299
France 957 1.319 28.701 -0.917 -22.338 -0.006 -0.676 0.440
Belgium 518 1.131 21.976 -0.996 -29.279 0.132 6.778 0.769
Italy 616 0.241 3.311 0.774 8.031 0.883 43.657 0.760
Denmark 872 0.766 22.028 -0.007 -0.239 0.067 8.177 0.095
Germany 579 1.407 26.470 -0.571 -14.061 -0.007 -0.686 0.488
India 1110 0.740 33.158 -0.217 -8.138 0.053 9.540 0.203
Netherlands 920 0.840 26.177 -0.623 -23.319 0.088 10.010 0.572
Portugal 1075 3.452 24.119 -1.048 -5.508 0.016 0.448 0.031
U.S. 750 0.697 12.103 -0.726 -10.631 0.237 14.408 0.452
Nobs Constant Slope on LMU dummy Slope on dummy for Slope on dummy for Slope on average bond Adjusted R2
LMU plus gold LMU without gold yield spread
Panel B: LMU credibility
France 957 1.211 37.602 -0.546 -13.235 0.155
Belgium 518 1.460 81.930 -1.130 -39.207 0.749
Italy 616 4.136 13.007 -1.461 -4.469 0.032
France 957 0.855 18.923 -0.446 -11.112 0.098 10.669 0.245
Belgium 518 1.131 21.976 -0.996 -29.279 0.132 6.778 0.769
Italy 616 1.295 7.293 -0.780 -4.614 0.823 41.275 0.744
France 957 1.330 29.593 -0.886 -21.923 0.355 6.742 -0.033 -3.224 0.466
Italy 616 1.113 6.588 -0.088 -0.492 -0.912 -5.688 0.876 44.307 0.772
This table reports estimates of regressions of the bond yield spread (country bond yield minus British bond yield) on gold standard and LMU membership dummy variables, plus the average bond yield spread across all available countries. Maximum time period is 1822 to June 1914 with data availability indicated in Table 2. In some cases, regressions with regime slope dummy terms could not be estimated because the country did not change standards, changes in standards were too ambiguous to quantify, or the country's data are incomplete and, therefore, do not span more than one regime. As a comparison to the intercepts reported here, the average spreads for British colonies that were continuously on gold were 0.97% for Canada and 1.21% for South Africa. For countries with poor data but tumultuous histories, average spreads were 13.62% for Greece, 8.53% for Spain, 2.80% for Turkey, and 1.69% for Russia. The time series average of the cross sectional average spread for all countries is 2.50%. i-Statistics are reported to the right of each coefficient estimate. In Panel B, the third regression specification is not estimated for Belgium due to insufficient data.
cf ^ # # <$> # ^ ^ # #
& J? ^ ^ ^ ^
| » Belgium □ France + Italy |
?. î:
:■■■?■ . ;; !» 1
■.if' iT-l & 1 v
182201182701183201183701184201184701185201185701186201186701187201187701188201188701189201189701190201190701191201
-Spain
Fig. 2. Monthly spread between sovereign debt and U.K. bond yields.
terms. This is consistent with the country's continually close tracking of German economic and monetary conditions and policies. Second, bond yields of Italy and Spain are significantly correlated with those of Germany only during the post Maastricht convergence and formal euro periods. This is consistent with the volatile economic and monetary conditions in Italy and Spain vanishing as those countries agreed to converge to the Maastricht criteria. In comparing the Netherlands to Italy and Spain, it is evident that adoption of a demanding monetary regime is most significant for member states that previously suffered from poor policies and volatile conditions. In comparing this bond yield evidence from the modern EMS/EU to our earlier bond and private bill evidence on the LMU, it is also evident that the adoption of the LMU was not perceived as converging interest rates to those of the core member, France, or the leading gold standard country, Great Britain. In contrast, EMS/EMU membership often draws bond yields closer to those of Germany, particularly for those states that previously experienced relatively unstable economic and monetary conditions. The contrast
between Italy under the LMU and Italy in the EMS/EMU is particularly dramatic.
Panel C of Table 8 presents regression results on the convergence of EU member inflation to Germany's inflation. As was the case for bond yields in Panel B, there is strong evidence that inflation rates generally for a number of EU members are strongly correlated with German inflation regardless of the time period studied. The sample of countries for which this holds includes both core EU members that adopted the euro and others that did not. At the same time, the estimated coefficients on the (199202-199804) slope dummy terms suggest that, for a few states, inflation become less attached to core German inflation under the convergence criteria of the Maastricht Treaty. However, this is largely associated with "fringe" EU states Denmark, Great Britain, and Greece that did not subsequently join the euro area.
Panel D of Table 8 presents regression results on the convergence of EU member industrial production growth to Germany's industrial production growth. There is little evidence that
Table 8
Regressions relating modern European interest rates, bond yields, inflation, and industrial production to Germany.
Slope on Germany
Slope on
Germany x (199202-199804) dummy
Slope on
Germany x (199805-200012) dummy
Adjusted R2
Panel A: interest rates Non-Euro Denmark Greece Sweden U.K. Euro Austria Belgium Finland France Ireland Italy
Netherlands Portugal Spain Panel B: bondyields Non-Euro Denmark Sweden U.K. Euro Austria Belgium Finland France Ireland Italy
Luxemburg Netherlands Portugal Spain Panel C: inflation Non-Euro Denmark Greece Sweden U.K. Euro Austria Belgium Finland France Ireland Italy
Luxemburg Netherlands Portugal Spain
263 191 248 263
131 263 167 263 263 263 263 215 263
264 264 264
264 264 264 264 264 264 264 264 264 264
264 264 264 264
264 264 264 264 264 264 264 264 264 264
Panel D: industrial production Non-Euro
Denmark Greece Sweden U.K.
Euro Austria Belgium Finland France Ireland Italy
Luxemburg Netherlands Portugal Spain
251 263 263 263
263 263 263 263 251 263 263 263 263 263
-2.917 65.661 22.099 4.307
1.937 5.232 1.114 17.111 5.211 14.732 -7.350 35.898 6.470
7.226 -0.363
0.886 4.238 10.711 4.047 1.249 7.607 6.038 -1.355 7.405 9.614
59.446 107.355 79.567 51.643
25.714 42.100 67.659 80.847 79.845 111.625 26.103 12.456 163.437 88.743
-0.696 -0.268 -0.465 -0.141
-0.605 -0.042 -0.232 -0.246 1.082 -0.072 -0.221 -0.296 0.267 -0.419
-0.122 0.289 0.886 0.335
0.286 0.450 0.043 1.241 0.218 0.438 -0.901 0.653 0.327
-0.566 1.061 -0.047
0.303 1.032 1.317 0.719 0.160 0.977 1.402 -0.383 0.578 1.294
6.216 3.701 6.022 4.131
2.945 6.395 8.003 13.802 3.319 14.545 3.161 1.455 9.710 8.878
-0.226 -0.371 -0.757 -0.589
-0.337 -0.056 -0.635 -1.065 0.168 -0.160 -0.270 -0.531 0.138 -0.096
0.176 0.003 0.602 0.124
0.312 0.281 0.210 0.205 0.214 0.002 0.339 0.901 -0.056
0.421 0.372 0.577
0.236 0.450 0.250 0.633 0.783 0.120 0.075 0.932 0.064 0.130
0.239 0.384 0.139 0.474
0.361 0.322 0.242 0.274 0.759 0.353 0.456 0.151 0.192 0.291
0.103 0.135 -0.030 0.102
-0.032 0.533 0.036 0.232
0.444 0.078
0.996 0.001 3.327 1.299
3.260 0.724 2.001 1.208 0.006 5.599
1.261 -0.384
3.447 3.841 5.297
5.682 7.709 2.158 7.920 7.048 1.082 1.231 18.523 0.349 1.234
2.432 1.288 1.025 3.686
4.022 4.751 2.785 4.553 3.066 4.473 5.369 1.717 1.108 2.829
0.170 0.907 -0.238 2.072
-0.087 3.397 0.473 4.854 -0.066 0.797 0.958 -0.646 1.110 0.086
0.015 -4.885 -2.251 -0.039
0.513 -0.125 0.667 -1.025 0.510 0.267 0.534 -3.999 -0.232
0.624 0.662 0.446
0.550 0.416 0.377 0.370 0.096 1.092 0.136 -0.033 0.443 0.911
-0.360 -1.778 0.022 -0.722
0.356 0.127 -0.132 -0.188 -0.696 -0.237 -0.271 -0.165 -0.014 -0.208
2.159 -0.562 0.154 -0.052
1.672 -0.679 -0.032 -0.186 -0.207 -0.038 -0.487 -0.023 -0.386 -0.484
0.019 -0.931 -3.012 -0.093
2.900 -0.329 1.289 -2.270 0.652 0.242 2.002 -2.686 -0.358
2.356 3.154 1.889
6.101 3.286 1.505 2.135 0.400 4.555 1.023 -0.303 1.122 3.977
-2.055 -3.348 0.093 -3.155
2.229 1.055 -0.855 -1.753 -1.581 -1.686 -1.793 -1.052 -0.045 -1.135
-1.749 0.562 -0.486
2.092 -2.005 -0.196 -1.811 -0.077 -0.192 -1.336 -0.092 -0.446 -0.249
0.569 0.451 -0.155 0.465
0.650 0.674 0.769 0.876 0.733 1.037 0.519 0.406 1.139
0.434 0.498 0.250
0.659 0.470 0.819 0.266 0.194 0.739 0.814 0.029 0.274 0.756
0.086 -2.279 -0.294 -0.319
0.092 0.455 0.275 0.162 -0.081 0.155 -0.462 -0.261 0.273 0.203
-5.231 0.078 -0.732 -0.073
-1.971 0.668 0.378 -0.191 -0.879 0.455 -0.157 0.352 -0.444 -1.455
-0.142 0.754
3.420 1.212 1.127 1.325 0.640 0.643 1.327 0.198 1.200
1.008 1.458 0.652
4.495 2.284 2.009 0.944 0.496 1.893 3.770 0.162 0.426 2.028
0.261 -2.288 -0.648 -0.743
0.305 2.011 0.948 0.805 -0.099 0.589 -1.629 -0.886 0.472 0.590
-2.377 0.141 -1.551 -0.398
- 1.431 1.146 1.347 -1.076 -0.191 1.320 -0.250 0.822 -0.299 -0.435
0.006 0.007 0.063 0.011
0.638 0.052 0.047 0.040 0.012 0.003 0.158 0.035 0.006
0.108 0.162 0.168
0.388 0.347 0.066 0.303 0.209 0.123 0.076 0.635 -0.003 0.111
0.225 0.157 0.172 0.187
0.170 0.297 0.297 0.564 0.113 0.584 0.195 0.023 0.336 0.341
0.039 0.013 0.013 0.019
0.029 0.060 0.012 0.088 0.000 0.013 0.008 0.006 0.005 0.001
Interest rates are first differences of three-month interbank rates, bond yields are first differences of 10-year government bond yields, inflation is the log difference of consumer price indexes, and industrial production is the log difference. Time period is January 1979 to December 2000 and all data are monthly. Specifications include slope dummy terms to isolate the period between the Maastricht Treaty (February 1992) and the approval of the Euro Plan (May 1998), and the period thereafter. t-Statistics are reported to the right of each coefficient estimate. A trend term (unreported) is included in all regressions to pick up the substantial drop in interest rates and inflation over the period studied. In Panel B, Greece is excluded due to insufficient data.
Constant
Table 9
Regressions to assess EMS/EMU credibility using spreads of bond yields over German bond yields.
Constant
Slope on Germany x(199202-199804) dummy
Slope on Germany x (199805-200012) dummy
Slope on average bond yield spread
Adjusted R2
Non-Euro
Denmark 264 -0.010 -0.388 0.272 1.304 0.037 0.100 1.217 10.008 0.278
Greece 95 -0.145 -3.086 -0.884 -3.464 -0.050 -0.123 1.341 3.920 0.283
Sweden 264 0.012 0.619 0.255 1.530 0.020 0.068 1.065 10.978 0.317
U.K. 264 -0.004 -0.169 0.188 0.963 -0.048 -0.139 0.855 7.501 0.179
Austria 264 0.012 1.111 -0.064 -0.714 0.007 0.046 0.768 14.662 0.460
Belgium 264 0.008 0.685 0.015 0.138 0.023 0.126 0.723 11.774 0.350
Finland 264 0.012 0.477 -0.134 -0.640 0.226 0.615 1.124 9.234 0.253
France 264 0.007 0.431 0.170 1.255 0.015 0.065 0.810 10.285 0.290
Ireland 264 -0.008 -0.327 0.041 0.209 0.095 0.275 0.817 7.114 0.164
Italy 264 0.012 0.554 0.512 2.853 0.067 0.214 1.468 14.027 0.433
Luxemburg 264 0.013 0.887 -0.595 -4.682 0.023 0.102 0.942 12.724 0.435
Netherlands 264 -0.002 -0.164 -0.061 -0.644 -0.006 -0.038 0.222 4.043 0.064
Portugal 264 -0.008 -0.206 -0.163 -0.501 -0.431 -0.755 1.623 8.558 0.228
Spain 264 0.013 0.584 0.311 1.699 0.068 0.212 1.293 12.124 0.362
This table reports the estimates of regressions of the bond yield spread (country bond yield minus German bond yield) on EMS/EMU regime dummy variables, plus the average bond yield spread across all available countries. Time period is January 1979 to December 2000 and all data are monthly. Specifications include slope dummy terms to isolate the period between the Maastricht Treaty (February 1992) and the approval of the Euro Plan (May 1998), and the period thereafter. t-Statistics are reported to the right of each coefficient estimate.
monthly industrial production across EMS/EMU members converges to Germany's industrial production growth. This matches what we found for our real activity proxy, the rate of growth of trade, during the LMU era. In brief, the modern European monetary system appears more different and, in particular, more credible than the LMU on the bond yield and inflation dimensions.
Table 9 uses the bond yield spreads to assess EMS/EMU credibility in a manner similar to the assessment of the credibility of LMU and gold standards presented earlier in Table 7. In contrast to what we found for the LMU era, there is virtually no evidence that the credibility of the modern European monetary system varies with specific developments in the EMS/EMU. It suggests a uniformly credible system throughout its life. Note that the brief sample of modern data that we have selected does not span the very recent global credit crisis and concerns about defaults by Greece, Ireland, or other euro-area members.
6. Summary and conclusions
We study financial and economic indicators from the era of the Latin Monetary Union, an interesting nineteenth century currency system which may be thought of as a precursor of modern European monetary and currency arrangements. The Latin Monetary Union was adopted in 1865 by France, Belgium, Italy, and Switzerland, and by other countries either formally or informally in subsequent years. Our empirical results are based on an extensive, though incomplete, database of exchange rates, interest rates, bond yields, inflation rates, and trade figures that span a period of about 90 years from the early 19th century to the outbreak of the First World War.
We find that membership of the LMU or adoption of a gold standard is frequently associated with lower volatility of private
bill yields, bond yields, inflation, and deviations from Purchasing Power Parity. This result, however, does not extend to Italy. We also find that LMU membership or gold standard does not induce convergence with the key LMU economy, France, or the key gold standard economy, Great Britain. Thus, we have tentative evidence that gold money or LMU membership "mattered" to financial and economic volatility but did not appear to induce "convergence" with key economies. The weakness of the LMU is confirmed by bond yield spread evidence suggesting that gold standard adoption was "credible" while LMU membership was not. The evidence on Italy is strongly consistent with the weak fiscal and monetary policies of the Italian government, and is a reminder that mere membership of a seemingly responsible currency standard does not confer economic success or respectability in the money and bond markets. In contrast, some results on modern European bond yields and inflation rates suggest that development and implementation of the EMS/EMU has been effective in inducing convergence to the German economy, most notably for Italy and Spain. Analysis of more recent EMU data is warranted given the recent concerns with the cred-itworthiness of several EMU members. It may be the case that, given more recent evidence, the analogy between the LMU and modern European monetary arrangements will be stronger.
We acknowledge limitations to our use of very old data from the LMU period. The data series are not complete or, in many cases, are available only annually. This limits our ability to employ more powerful and interesting statistical techniques.4 Furthermore, money markets and bond markets may have been less liquid or efficient in responding to information or changes
4 For example, Hallwood et al. (2000) apply a GARCH specification to detect risk premiums for the U.S. dollar in the period 1890-1897.
in monetary regime than modern markets.5 Thus, money market and bond yields may not reflect precisely the impact of LMU events on the economies of member states. In spite of this, our results are interesting and, in particular, highlight differences between the LMU and modern EMS/EMU, and contrasting role of Italy across the two agreements.
Acknowledgement
We thank Jim Lothian for helpful suggestions. References
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5 For example, Tuniolo et al. (2002) find that bond pricing across Italian cities varied considerably, implying impediments to arbitrage and trading in spite of the lack of any barriers or other costs.
