Working Paper: NBER ID: w1039
Authors: Rudiger Dornbusch; Jacob A. Frenkel
Abstract: This paper examines the operation of the gold standard and the performance of the Bank of England during the crisis of 1847. The key feature of that crisis has been its origin: it originated from a massive real shock rather than from monetary disorder. A harvest failure gave rise to commercial distress and financial panic.Following a brief outline of the main events during the 1847 crisis, we present asimple model of the financial sector that captures the central characteristics of the crisis. The model, which highlights the role of confidence in both external and internal convertibility, is then used for interpreting the detailed characteristics of the financial crisis.Faced with a confidence crisis leading to international and external monetary drains,the Bank of England suspended Peel's act and thereby was allowed to issue fiat money without being constrained to have full gold backing. Our analysis shows that suspension of Peel's act was the proper policy required for the restoration of confidence. It also sheds light on the role of a lender of last resort in cases of banking panic.As for the evaluation of the gold standard, the 1847 crisis demonstrates that International capital flows have played a key role in the adjustnent mechanism. Further, it demonstrates that in contrast with the traditional representation, the gold standard has not been characterized by automatic, non-discretionary adjustment. On the contrary,banking policies and changes in the reserve-deposits and currency-deposits ratios have affected the money stock independently of gold flows.
Keywords: Gold Standard; Bank of England; Crisis of 1847; Financial Panic; Monetary Policy
JEL Codes: N1; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| harvest failure (Q54) | 1847 crisis (H12) |
| 1847 crisis (H12) | suspension of Peel's Act (P37) |
| suspension of Peel's Act (P37) | restoration of confidence in banking system (G28) |
| suspension of Peel's Act (P37) | issuance of fiat money (E42) |
| banking policies and reserve-deposit ratios (E58) | money stock (E51) |
| 1847 crisis (H12) | financial panic (G01) |
| suspension of Peel's Act (P37) | stabilization of banking system (G28) |
| international capital flows (F32) | adjustment mechanism (F32) |