SSE/EFI Working Paper Series in Economics and Finance
Michael D. Bordo
A Return to the Convertibility Principle? Monetary And Fiscal Regimes in Historical Perspective.
() and Lars Jonung
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.
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.
Keywords: Gold standard; convertibility; monetary regimes; Bretton Woods.; (follow links to similar papers)
JEL-Codes: E50; E60; H60; N10; (follow links to similar papers)
66 pages, December 6, 2000
Forthcoming in Axel Leijonhufvud, ed., Monetary Theory as a Basis for Monetary Policy, MacMillan.
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