Comparing Greece in Gold Standard vs Greece in Eurozone

A super paper on the topic. Greece may be in real bad shape but its central bank econs have some decent papers on many aspects of Greece and Eurozone economies.

The origins of the Greek-sovereign debt crisis were the country’s large fiscal and external  imbalances. The key factor that abetted those imbalances was the absence of a short-tomedium term adjustment mechanism — due to perceptions of sovereign bailouts — in the  euro-area that would have reduced members’ external imbalances. This situation  contrasts sharply with the adjustment mechanism under the classical gold standard. Under  the gold standard, countries with external deficits would experience losses of gold  reserves, higher interest rates, lower money and credit growth, and reductions in wages  and prices, which helped restore trade competitiveness. We draw two main conclusions.  First, the durability of a monetary union is crucially dependent on the existence of a wellfunctioning adjustment mechanism. Second, adherence to a hard peg is no panacea and  cannot be sustained without the support of credible fiscal institutions.

The paper has some nice basics on functioning of economies under gold standard. Even then there were core and periphery members with former having stronger finances and latter having weaker finances.

What countries were members of the classical-gold-standard club?

Historians  distinguish between “core” members of the classical gold standard and the peripheral  members. Core countries include France, Germany, and the United Kingdom, with Belgium and the Netherlands also sometimes considered part of the core category. Among the common features of these countries are that each had relatively-welldeveloped financial markets and each had a national central bank. The periphery included Canada, South Africa, the United States and parts of Latin America (e.g. Argentina,  Brazil, Mexico), Asia (including Australia, New Zealand) and Europe (e.g. AustriaHungary, Greece, Italy, Spain, Portugal, Russia, Switzerland, the Scandinavian countries).

Their economies were typically financially less-developed than those of the core countries and most of them did not have a national central bank during at least part  of the gold-standard period. Some of the peripheral countries participated in the gold standard only during part of the 1880-to-1913 period. Additionally, some countries that were not formally on the gold standard nevertheless followed policies that were consistent with a fixed price of their currencies against gold in an effort to “shadow” the gold standard. With regard to  countries that are sometimes considered to have been members of the European periphery, the following particular circumstances merit comment.

Greece became a member but opted out soon:

Greece joined the gold standard in January 1885 but dropped out in September of  1885, because, as Lazaretou (2004, p. 14) noted, the government failed to control  the fiscal deficits and thus to support the credibility of the system. It rejoined the  gold standard in 1910. Given the very-limited duration of its participation in the gold standard, and the inconsistency of its policies with such participation, in what follows we do not consider Greece to have been a member of the periphery.

So similar problems but Greece continued in EZ but dropped out of GS.

The paper nicely explains the adj mechanism in GS:

For its core participants, the gold-standard regime possessed an adjustment mechanism that served to reduce external imbalances (Scammell, 1965; Eichengreen, 1996). Consider first the operation of the gold-standard adjustment  mechanism in the absence of capital flows. To simplify the discussion, let us assume a  two-country world comprised of Greece and Germany in which Greece runs a trade deficit and Germany runs a trade surplus. Let us also assume that only gold coins circulate and prices and wages are flexible in both countries. In such a situation, the goldstandard adjustment process — called the price-specie-flow mechanism – worked as  follows: 

• Greece experiences a gold outflow, decreasing the money supply and reducing credit growth (perhaps reducing the quantity of credit) in that country, causing prices and wages to fall.
• Germany experiences a gold inflow, increasing the money supply and raising credit growth in that country, causing prices and wages to rise.
• As a result of the change in relative prices, Greece’s exports rise and its imports fall, eliminating its trade deficit. The opposite occurs in Germany.

Even this gold outflow would not be needed if central banks raised policy rates:

Capital flows reinforced the overall self-equilibrating character of the system as it operated in the late-19th and early-20th centuries. Typically, the central bank of a country experiencing a trade deficit would increase its discount rate, reducing its holdings of domestic interest-bearing assets and drawing cash from the market (Eichengreen, 1996, p. 28). This action produced two main effects. First, the money supply and credit growth in the country raising rates declined, reducing (or eliminating) the need of gold outflows from that country. In fact, capital could flow into the country as a result of the rise in the discount rate, smoothing the required adjustment. Second, the rise in interest rates would reduce economic activity in the country concerned, decreasing prices and, thereby, contributing to the elimination of the country’s external imbalance, through both relativeprice adjustment and the decrease in demand.

The pre-World War I gold standard operated in the above manner among the core participating countries (Scammell, 1965, p. 35). The core countries possessed the institutional capacity to make their commitment to the gold standard credible; therefore, they were able to issue debt denominated in their own currencies (each of which represented a certain amount of gold).

USeful read. A nice primer on GS as well..



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