Adjustment under the Classical Gold Standard: How costly did the external constraint come to the European periphery?

"Conventional wisdom has that peripheral economies had to ‘play by the rules of the game’ under the Classical Gold Standard, while core countries could get away with frequent violations. Drawing on the experience of the two largest peripheral economies in pre-World War I Europe, ie Austria-Hungary and Italy, my paper challenges this view. Based on a vector error correction model and impulse response functions, it is shown that even the so-called periphery embarked on sterilisation policies and was not forced to use the discount rate tool in a way that would have put the domestic economy under too much strain. In the second part of the paper, I turn to a comparison of the two countries: what explains that Austria-Hungary retained more room for manoeuvre than Italy (another result of the VEC model)? Based on a reconstruction of the balance of payments and other economic indicators, I argue that Austria- Hungary was integrated into the global financial system in a more sustainable way; Italy’s adherence to gold, by contrast, depended on several circumstances beyond her control, most importantly the steady influx of remittances."