The political economy of exchange rate stability during the gold standard. The case of Spain, 1874-1914

This article contributes to the literature on central bank independence and monetary stability during the classical gold standard era. On the eve of the First World War, European periphery had not achieved stable adherence to gold despite the protection of central banks against political pressures to monetize debt. In the 19th century, most issuing institutions were private banks whose main objective was profit maximization. As a result, monetary stability depended on negotiations between monetary and fiscal authorities and not directly on central bank independence as is the case nowadays. Strong governments were needed to impose the objective of monetary stability on central banks in negotiation practices. To test our argument, we have constructed indicators of government strength and central bank independence to measure bargaining power for the case of Spain. Results confirm that a highly independent private central bank avoided the responsibility of defending gold adherence when negotiating with weak government, even in a stable macroeconomic environment. Our research suggests that the success of central bank independence in generating monetary stability during the gold standard period depended on sound political institutions.