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A Return to the Convertibility Principle? Monetary And Fiscal Regimes in Historical Perspective

Author

Listed:
  • Bordo, Michael D.

    (Department of Economics)

  • Jonung, Lars

    (European Commisson)

Abstract
What is the long-run relationship between monetary and fiscal policies? This paper provides an answer by examining a large set of data covering major economies during the past 115 years. The evidence suggests the existence of a close interaction between the monetary regime, that is the behaviour of the central bank/monetary authorities, and the fiscal regime, that is the tax and spending behaviour of governments as reflected in the evolution of budget deficits and public debt. In the past, a monetary regime based on the commitment to convertibility of the domestic currency into specie, the 'convertibility principle', was the prevailing pattern in the world economy. According to this principle, the fiscal regime is subordinated to the monetary regime. The monetary regime places binding constraints on fiscal policies. The major exception to this pattern occurred during major wars and their immediate aftermath when fiscal demands determined monetary policy. Since the mid 1960s and especially after the breakdown of the Bretton Woods system in the period 1971-73, monetary policy has abandoned the 'convertibility principle' and in many countries has been geared towards domestic stabilization goals, especially that of full employment. This led to a build-up of inflationary pressures in the 1970s which has been largely rolled back since the early 1980s. In the same period bond-financed fiscal policy has been used as a stabilization policy tool, when many countries accumulated debt to income ratios sufficient to threaten monetary stability. These results suggest a prediction for the future. If fiscal balance is restored in most major economies, monetary regimes based on either an internal commitment such as the goal of price stability or low inflation or an external commitment to peg to a foreign currency will prevail.

Suggested Citation

  • Bordo, Michael D. & Jonung, Lars, 2000. "A Return to the Convertibility Principle? Monetary And Fiscal Regimes in Historical Perspective," SSE/EFI Working Paper Series in Economics and Finance 415, Stockholm School of Economics.
    • Handle: RePEc:hhs:hastef:0415
    Note: Forthcoming in Axel Leijonhufvud, ed., Monetary Theory as a Basis for Monetary Policy, MacMillan.
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    References listed on IDEAS

    as
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    Citations

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    Cited by:

    1. Tomasz Brodzicki, 2012. "On optimality or non-optimality of the eurozone," Working Papers of Economics of European Integration Division 1201, The Univeristy of Gdansk, Faculty of Economics, Economics of European Integration Division.
    2. repec:spo:wpmain:info:hdl:2441/622 is not listed on IDEAS
    3. Agnes Benassy-Quere & Jean Pisani-Ferry, 2011. "What International Monetary System for a Fast-Changing World Economy?," Book Chapters, in: Jack T. Boorman & André Icard (ed.), Reform of the International Monetary System: The Palais Royal Initiative, edition 1, chapter 21, pages 255-298, Emerging Markets Forum.
    4. Andersson, Fredrik N. G. & Jonung, Lars, 2018. "Lessons for Iceland from the Monetary Policy of Sweden," Working Papers 2018:16, Lund University, Department of Economics.
    5. U. Michael Bergman & Michael D. Bordo & Lars Jonung, 1998. "Historical evidence on business cycles: the international experience," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 42(Jun), pages 65-119.
    6. Michael D. Bordo & Marc Flandreau, 2003. "Core, Periphery, Exchange Rate Regimes, and Globalization," NBER Chapters, in: Globalization in Historical Perspective, pages 417-472, National Bureau of Economic Research, Inc.
    7. Reinhart, Carmen & Trebesch, Christoph, 2014. "A Distant Mirror of Debt, Default, and Relief," CEPR Discussion Papers 10195, C.E.P.R. Discussion Papers.
    8. António Portugal Duarte & João Sousa Andrade, 2012. "How the Gold Standard functioned in Portugal: an analysis of some macroeconomic aspects," Applied Economics, Taylor & Francis Journals, vol. 44(5), pages 617-629, February.
    9. Bordo Michael D. & Dittmar Robert D & Gavin William T., 2007. "Gold, Fiat Money, and Price Stability," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-31, August.
    10. Lucio Sarno & Giorgio Valente & Mark E. Wohar, 2004. "Monetary Fundamentals and Exchange Rate Dynamics under Different Nominal Regimes," Economic Inquiry, Western Economic Association International, vol. 42(2), pages 179-193, April.
    11. Raoul Lättemäe, 2001. "Monetary transmission mechanism in Estonia - some theorethical considerations and stylized aspects," Bank of Estonia Working Papers 2001-4, Bank of Estonia, revised 13 Oct 2001.
    12. Berg, Claes & Jonung, Lars, 1999. "Pioneering price level targeting: The Swedish experience 1931-1937," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 525-551, June.
    13. Peter L. Rousseau, 2003. "Historical perspectives on financial development and economic growth," Review, Federal Reserve Bank of St. Louis, vol. 85(Jul), pages 81-106.
    14. Lars Jonung, 2002. "EMU and the euro - the first 10 years. Challenges to the sustainability and price stability of the euro area - what does history tell us?," European Economy - Economic Papers 2008 - 2015 165, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    15. Pedro Bação & António Portugal Durate & Mariana Simões, 2013. "The International Monetary System in Flux: Overview and Prospects," GEMF Working Papers 2013-07, GEMF, Faculty of Economics, University of Coimbra.
    16. Michael D. Bordo & Lars Jonung, 1999. "The Future of EMU: What Does the History of Monetary Unions Tell Us?," NBER Working Papers 7365, National Bureau of Economic Research, Inc.
    17. repec:hal:spmain:info:hdl:2441/622 is not listed on IDEAS

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    More about this item

    Keywords

    Gold standard; convertibility; monetary regimes; Bretton Woods.;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • H60 - Public Economics - - National Budget, Deficit, and Debt - - - General
    • N10 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - General, International, or Comparative

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