On the behaviour of UK money, velocity, prices, and output in the gold standard period: 1871–1913

Abstract

This article provides evidence in support of cointegration among the UK money supply, real output and the price level in the gold standard period, 1871–1913. The series respond to eliminate short run deviations from the long run equilibrium relation of the equation of exchange. Cointegration is also observed between the UK and US price levels, with the former also responding to eliminate short run deviations from the long run equilibrium relation among the two price levels. Our results for the components of the quantity equation support arguments that the Bank of England moved short-term interest rates in response to changes in domestic economic activity, taken to be an indicator of future changes in its gold reserve position. Our evidence concerning the UK–US price levels supports the rising position of the United States as an economic power during this period.

Acknowlegements

The authors gratefully acknowledge the comments and suggestions of an anonymous referee on an earlier draft of this article.

Notes

¹See, for example, Bordo and Schwartz (1984), Goodhart (1984a, 1986 [1972]), Eichengreen et al. (1985), Gerlach (1993), Davutyan and Parke (1995), Tullio and Wolters (2000), Canjels et al . (2004).

²The Friedman and Schwartz money supply data begins in 1871. We end our sample period in 1913 due to the outbreak of World War I in the following year.

³It is often argued that the ADF tests with the null hypothesis of a unit root against the alternative of trend stationarity have low power. Accordingly, Kwiatkowski et al . (1992) propose a procedure (the KPSS test) which tests the null hypothesis of stationarity against the alternative of a unit root. To check the robustness of the ADF unit root test results reported in Table 1, we have also utilized this test with critical values from Kwiatkowski et al . (1992). The KPSS test statistics for M_t , Y_t , P_t and Pf_t are, respectively, 0.125, 0.117, 0.208 and 0.208 which are all significant and lead to the rejection of the null hypothesis of trend stationarity in favour of a unit root for all these series.

⁴In general, with three I(1) series, there is the possibility of having at most two cointegrating vectors. Since any linear transformation of the cointegrating vectors is also a cointegrating vector (Johansen and Juselius, 1990), the existence of two cointegrating vectors in a three-variable model means the series are pairwise cointegrated; that is, there exist linear transformations of the original vectors that eliminate one of the three variables from each cointegrating equation. In our case, the possibility of having two cointegrating vectors is thus ruled out, since, as shown in Row 7 of Table 1, cointegration disappears when excluding Y_t .

⁵The ADF test equation for R_t includes only an intercept. The corresponding KPSS statistic for R_t is 0.141, which is insignificant, and thus we cannot reject the null hypothesis of stationarity.

⁶See, for example, Goodhart (1986 [1972], pp. 195–208; 1984b).

⁷Bordo and MacDonald (2005) demonstrate that the credibility of the classical gold standard allowed a sufficient degree of monetary policy independence for the Bank of England to be able to accomplish this within the fixed exchange rate system.

⁸In 1879 the ‘greenbacks,’ issued during the American Civil War, were made convertible into specie. The US Treasury was allowed to buy silver as well as gold until the Gold Standard Act of 1900, but in fact only bought silver as necessary to maintain the silver coinage or when specifically directed to and in practice redeemed both its gold and silver certificates in gold if demanded.