Stability Without a Pact? Lessons from the European Gold Standard 1880-1914

The high level of trade and financial integration reached by Europe both today and under the late 19th century gold standard suggests that important lessons can be learned by looking at past record to inform current issues. In this article, we draw a fresh picture of the European gold standard, and use it to derive a number of useful implications. The paper’s basic finding is that the stability of the European gold standard depended on the stance of the common monetary policy. Under the gold standard, this stance was disturbingly deflationary prior to 1895. As a result, debts became exceedingly heavy and monetary standards crumbled under their weight, not so much because fiscal policies became looser, but rather because debt burdens became unsustainable in the wake of continued deflation. Once gold was discovered and deflation gave way to inflation, real interest rates fell and debt grew more slowly. This study’s clear implication for the EMU zone, is that stability will hinge on the European Central Bank’s (ECB) policy not being too restrictive.