EVIDENCE FROM THE CLASSICAL GOLD STANDARD Michael D. Bordo Angela Redish Work

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NBER WORKING PAPER SERIES
IS DEFLATION DEPRESSING?
EVIDENCE FROM THE CLASSICAL GOLD STANDARD
Michael D. Bordo
Angela Redish
Working Paper 9520
http://www.nber.org/papers/w9520
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
February 2003
The authors would like to thank Pierre St. Amant, Ramdane Djoudad and participants at the Claremont
conference on Deflation, as well as at seminars at Carleton University, Queen’s University, the University
of Colorado and the University of Western Ontario for very useful comments. The views expressed herein
are those of the author and not necessarily those of the National Bureau of Economic Research.
©2003 by Michael Bordo and Anglea Redish. All rights reserved. Short sections of text not to exceed two
paragraphs, may be quoted without explicit permission provided that full credit including ©notice, is given
to the source.
Is deflation depressing? Evidence from the Classical Gold Standard
Michael Bordo and Angela Redish
NBER Working Paper No. 9520
February 2003
JEL No. E31, N11
ABSTRACT
We distinguish between good and bad deflations. In the former case, falling prices may be
caused by aggregate supply (possibly driven by technology advances) increasing more rapidly than
aggregate demand. In the latter case, declines in aggregate demand outpace any expansion in
aggregate supply. This was the experience in the Great Depression (1929-33), the recession of
1919-21, and may be the case in Japan today.
In this paper we focus on the price level and growth experience of the United States and
Canada, 1870-1913. Both countries adhered to the international gold standard. This meant that the
domestic price level was largely determined by international (exogenous) forces. In addition,
neither country had a central bank which could intervene in the gold market to shield the domestic
economy from external conditions.
We proceed by identifying separate ‘supply’ shocks, money supply shocks and demand
shocks using a Blanchard-Quah methodology. We model the economy as a small open economy
on the gold standard and identify the shocks by imposing long run restrictions on the impact of the
shocks and on output prices. We then do a historical decomposition to examine the impact of each
shock on output. The results for the U.S. are clear: the different rates of change in the price levels
before and after 1890 are attributed to different monetary shocks, but these shocks explain very little
of output growth or volatility, which is almost entirely a response to ‘supply’ shocks. For Canada
the results are murkier. As in the U.S., the money supply shocks before 1896 are predominantly
negative and after that are largely positive. However, they are non-neutral, and relative to the U.S.,
money supply shocks play a larger role in determining output behavior in Canada.
The key conclusion of our analysis is that the simple demarcation of good vs. bad deflation,
where either prices fall because of a positive supply shock, or prices fall because of a negative
demand (money) shock does not capture the complexity of the historical experience of the pre-1896
period. Indeed, we find that prices fell as a result of a combination of negative money supply shocks
and positive supply shocks.
Michael D. Bordo Angela Redish
Department of Economics Department of Economics
Rutgers University University of British Columbia
New Brunswick, NJ 08901 Vancouver, B.C.
and NBER Canada V6T 1Z1
[email protected] [email protected]
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1 This is not to say that monetary authorities adhere to the principle of gold convertibility but that they are
detac iodt end owiotla .lryfo tneiicliirbpats
2 This is a slight simplification. The US suspended the gold standard during the Civil War, and only returned to
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3 y eted imiol o vt issl oeb kasr pi ndnre pedoxfrea tiehi reoetbfenrvT deultiometaehEfsmocnhrteisuoWlocc
insu lation. Bordo and MacDonald (1997).
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3
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ecnamrofrep – ta tsael yb eht erusaem fo rep atipac emocni htworg – outshone that of the US,
hguohtla eht SU saw llits ylkrats daeha ni.slevel 6 sA ni eht ,SU ereht etrneawcl iafciinlgciysc
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krats tsartnoc htiw SU cimo neoccneamrofrep ni ehtdim - s0781 del ot a noitargim fo snaidanaC
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ni na tpmetta ot tceto rlpaitneto ptna f.nsieirtsudni ehT tcapmi fo taht ffirat si :deta byeldniatrec
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5 He does not explain the pick up in growth after 1896, and suggests that it remains a puzzle.
6 In 1880 Canada and the US had the same gold parity and therefore an exchange rate of 1 between the two
.seicnerruc nI 0781 eht SU rallod saw deulav t ayletamixorpp a$C 57.0 sa a tluser fo eht noisnepsus fo dlog
convertibility during and after the Civil War.
7 yellO )dn( elbaT 72 dna elbaT.01
4
fo evisnetni htworg gnisir( rep atipac )semocni dna taht fo evisnetxe htworg g nisaercni(
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noitalu pgonpisaer cewsnhonithial pt xamehstin aseh a rc a wreetrehmoohtn t denehoswu csoafh
demussa( ot eb nevird yb eht y twielnibal ifaova )dnal nac nialpxe eht gnisir rep atip, aecmocni
tneiciffusn ismee ssmra ff oeula veh tn iesi reh ttah tnevig .sni aeg hntialp x oet 8
hatdoaB ndanCa eht y St rUinelot ii fnbtea ii ph()tfmt9rou 7ese8ver1nreowc no eh tdlog
ydn na. a mts nre0 eIek7yhGr8rta1a mtd eed yntlebocr hmeoytfwlfr a addlr niaeoamdrsinesawts
e h ftyotilibitrevn odcemus edr a SheU h9t7 8 y1db ndaradna tdsl oeg hdteni o)jylevitceff ee(cnarF
dertn s ona n anfameieei n e chrsgfdyatciaolfnhte i tsge,rrraeelwv e,wsok hcd.olktocsGabneerG
,dlog gniriuqer taht secirp .llaf erugiF 3 swohs taht launna dlog noitcudorp degareva tuoba6
noillimcnuo se morf0781 - .3981 dloG seirevocsid ni htuoS ,acirfA dna ot a ressel tnetxen i
.39 8r1et fnaoitcudo rdpl o fgsolev erlehg iyhllacitama r oddt e,lekidno leK hdt naailartsuA
erugiF a2 swohs eht ruoivaheb fo ecirp secidni rof SU dna .adanaC noitalfeDd egareva
y l% n2.o.a1. pni eht SU d ns asnealh t% 1n e 0aen7d wi 8a dt,1nene6av ab9Cit8tu 1abelhutmuc
tc erfef veeor onmah tsoewdt ascaewd a llaf ni e het clier vplellef fo %73 ni eht SU dna %12 ni
.adanaC sih Tnoitautis saw desreve rretfa 6981 nehw dlogvocsid sdeeisraeer cenhit labo lkgcots
fo dlog dna erofereht lanoitan yenom ,skcots dna secirp esor .ediwdlrow raluceS noitalfeds aw
. SeU hdt naadan ahCt o nbnioitalf nrialuc e ysdbecalper
elihW hto badanaC dna eht SU d ayhr astmeent osdmyessab no ,dlog e h’tedi synein‘om
tnenopmoc fo eht yenom ylppus saw decudorp rednu yrev tnereffid stnemegnarra ni ehto wt
.seirtnuo cnI ,adanaC a hcna rgbnikn ambetsys sa wdettimrep ot eussi knab seto nderuces yb eht
lsatrees nsfeaog e th,c tkeynjlabnbuo sot e htti mtialhtht yetitn afuoq seto nt odneec xeehtdiap -
ni .latipac sA a rettam fo ecitcarp eht sknab netfo dleh tnacifingi syenom ta llac ni weN, kroY
dehsil bma etg tsn.se i’y lkssn aneIe navh, o brtSeiye Uhtrsdtaae e Ndrhyknnceoo oihoschtlaews‘
ndi e 4tt6aa 8dhk 1ntnsaaembt ot dnnes)eebd%r mn1 ud lno1dceyarb1netbre(asaeve doraegcF
gnireit fo .sevreser 9 suhT eht SU gniknab metsys dah ytluciffid gnilaed htiw ehtl anosaes

8 The seminal article is Chambers and Gordo n .)6691( roF a yrammus fo eht etabed ees eirroN dna marwO.)6991(
9 sy krd ntaa nh boudto lC%o5h 1 fs e o teveh fiu r hcn dosl%ertiofl(oa0si houpv6eeew oerhbtcdti satoape da
esyv ktr; ednie)yvaac skt rhbsen ioe eradctshfv bl ecor%od%ri(e5hl0hs2 u5weeo rbcti sato aplea dratnec
5
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ev alhl iswkco hdsnam ende h,tlacitr e sveivr uyclpp uestagerg gna utrro hes h ft,iled odmnamed
nev iyrlderi tnn eeee vbdalh uhotww otrugp tnfurooet t ea dhp,nt naturr o ehnnhs eittvcea pomni
ehm ietm orso fg(nipo ldsraw p sueivr uyclpp uestagerg gea h ft.Iskco hyslpp uysb )noziro
alf n yidbewoll onfoitangats/noitalf eed hdt n,atupt u notocap m nieav adhlu oswkco hdsnamed -
. sk co hdsnam etdcelf ey ra,mhtworg/noit
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,elpma xreo fs(emig esrdo onWotte rd Bndaradna tdsl oggnitsartn onycillacip y,tseimonoce
seid uetss e.h)T)59 9n1e(ergneh c diinEmauo y da)nB8a9 9 e1 dy(gnNnait a,e)K39 9o1d(roB
am r se aaptha hntoitavon ne i hsktaco h’sylpp u dsae‘ifitne dd intaupt ud onsaeci rnapot addesu -
itnen tta ichasito dpde lrlup eoddwno amemteadgergga/yl peptuasg e. rtng uAgt pacntaoupom -
skco h’sylppu sd‘etamit see hsteidu teser hlt l na,irevew o,hseci rrpew odllu okwco hyslpp uesvit
.tcef fdeetcide rypllaciteroe he thfetotisop pe oh,tseci rntpocef feevitis otpnenam r deaaph 10 e nO
o rnpoitanalpxe s irdhoetfsop - dets eytlticilp xte otn ub - sakico hyslpp utsnanim oed htta h sti
e hd tnlaev eelci re phsthpa rbeg2rug i.Fseci rd pntaupt uhot osbesi ahrci h,wtcef feeda rfstomret
ad aesar ndmofaarfoCrett e reada rfstomr ed tnlaev eelci re phtta hetcnedi vleaus ascedivo rdpn
.detalerrocnu 11 1 7eg8hn1ti rgundivor peemr di asafmr o rte,ehettromreht ruF - n edhowi r6e9p81
s edcntiaurop tyaldip aers itrupt udo nsaeci repli hewtanga tnse hdt nganill aef raadan a nCtiup
e h nteilbair aevda r ftsomr edatedulc n e inw. ey hrWutn ehcteitne wet h ftgoninnig eebht
ida re thfntooitamitse ecir pesrevre peh tetanimil eto ndi ddn atnacifingisn isa wt iledo mlanoit
o h’sylppu se‘ h.Tkco h’sylppu sd‘etamit see h fttoceffe ts ulmed oemtairav ieb h ntdietamit skec

ev r yeel;stvsa)eirerkicertntsnaieebcrc – weN , k,roogYaci hdCna .tS siuoL – had to hold 25% reserves. Goodhart
(1969; 16).
10 .t cd tan nocpus osemoielfifvafiet ieshoTp
11 The contemporaneous correlation is - 0.24 and th e correlation is smaller at 1 or 2 leads or lags. Terms of trade
atad era morf kciD dna dyol F)2991 (elbaT.3.B
6
eh u tartituwp t dusnoeac isnrtopce fefveiti stonpenam r setap ahkhct odhns ad mnaeudofnoc
.kco h’sylppus‘ 12
en odmradna thast itwnetsisn o sctia hetmeh cnsoitacifitne deivitanret l naeasopo r epW -
.dradna tdsl oe g hnytomono cnee plol a rm aoslfed oymrat 13 ,tu p rtfuuooo iva heleh eb tdeoWm
e htta hgtnimus s yasbecnabruts icditsahco teser hytfitne ddi nkaco tysen oem hdt nsaecirp
citse m eo dhdtntuap tsrueooc irreph ttnicoea p nmgui nr sooeanlchnabrut sdindamed ylppu s
n ugrn oel h nttia hgtnimus sea r ea,wylticilp m.Ilev eelci rep h nttocap mni ugrn o olsn akhcohs
tY e.L)swo lyfraten ohmguorh tl(ev eelci rdplr oew h ytnbw odde ist alwev eelci rcpitsem oedht
t ed ln,akco tysen oe d mhMnltaev eelci re ,phPP tDlGa etrneserper ,kco h’sylppu se‘ hetb
es
d n,akco hyslpp uysen oemht .kco h)sylpp uysen onma hrteh tdonam e, dstiah td(na m ead
ems ed
ere hxwirt armeilpitl unm ugrn oel hsttneserp e)r1 (xAirt aem h ft,inehT atnemel ehca e (1)
ij
,eti rn w a e,cewilbair aknjvcoo hftsocef fn eugrn oe lhsterutpac
Ø D P ø Ø a (1 ) 0 0 ø Ø e ø
11 sm
Œ œ Œ œ Œ œ
D Y = a ( 1 ) a (1 ) 0 e
Œ œ Œ 12 22 œ Œ s œ
μ D M ϧ μ a (1 ) a ( 1 ) a (1 ) ϧ μ e ϧ
13 23 33 d
er enhoitpmus slaaciti rec htt u,blaisrevortnoc n sukico hdsnam eed h ftnooitacifitne deihT
ll ae m hs ntyol e erewr e.Hn ugrn oel h ntliev eelci rep httcef fta o onsdkco h’sylppu st‘a hsti
.suonego xsleaev eelci re phstek aytmono cceitsem oe dhhtci hrwed nnuoitpmus syamono cneepo
citsem oe dhocttifice pesr etwa hstkco hyslpp usserutp akcco hyslpp ue shtta hetmus seaW
ymonoce – ev ath odn idd na lev eelci rdplr oew h nttocef f nea in the long run. yelwtnatropmI(
dn itab o snnioitcirts eer hdtnif ymono cSee Uhr toe fngoni - imuoy ahBt itwnetsisn otclus ear
ir odahn iof hnweergnehc idEna ftonanimret erdoj ae mhe tc)n .ieSvr udcnam eedtagerg glaatnoz
n , or d fi eelko tofwocectegohu rhtdd solgrrn poi dw g so rnseaireaeh wruvhctdeoocilprrpow

12 si r eid emns) Soae4nln9 oaa9riCH1o s (fdsf euo endc sc .anseenmdseihceonktdtr tracxufsfmoeooiehssdsrep
13 Our identification strategy is similar to that of Dupasquier, Lalonde and St. - Amant (1997). They use a tri - variate
Blanchard and Quah decomposition with the same ordering to identify monetary, supply and non - yratenom
dsnkacm oerhdosf ehttsop - no t st,dedorooBiW rteupb tesseusreettanri rather than the money stock (and assume
that the price level is I(2)).
7
.kco hyslpp uysen oem h stsaeci r nptocap mni ugrn osa lathaht 14 f onoitacifitned isih tgni s U
e hytletarap eesrusa enm a ecswkco hyslpp uysen odm nyalppus tceff efo hcae n.otuptuo
.ntIu p streuo co tincroep ftfneena m er ovetn apashhetslu psmeirut pkac codhr siehhtT
,skco hdsnam eSydIllaitnes se erease hdtradna tdsl oe g hnytomono cnee plol a fmtaosxetn oecht
S fI.Inoitacifice plsacirip msei h ntdielgnatnes i edtbonn ayce hdt n,askco hdsnam eyden ormo
ll i twdi n,aevitis o eplbl iswelbair aever hlt l nakoco hes h fttocef ftecap mei h,tetanim osdkcohs
d nsaeci rnpe hettanim osdkco hdsnam eyden o fm.Ikco tysen oem h nttocef fne ugrn o olenvah
ll itwuptuo .kco tysen oem h nteisaerc ntinenamr e eaplbl iewre hdt ntacap m nilolaf
d nsanoitcirts eer hgtnisop m yidb n,aralugnai rrtew o sl)i1 (tAa hytlp msinoitcirts eer hT
s r)feLot(eA m eaet rha,at mlp eianwtnasoceg o shekt rc re a otoeneharohshhittttpm ueshsta - eht
snoitcn uefsnops eerslupmi -.snoitavon nliarutcur tes hytfitne ddi na 15 fyotidil aev h otyt eek hT
e hhtt itwnetsisn osctcej byofitne ddieed nsinoitcirts egrniyfitne dei htta h styigolodoht esmiht
ss oiitt h sytoleatatw u es.hulTe dloamciteroeht , stia h.Tsnoitcirts egrniyfitnedire ve ohtktao ol
gn oel hrt osfnoitacilp msi ayhroeht - nur dntarohs - .elbair ahvc a nekoco hhsc a fesotcap mniur
dnam eyden ocmitsahco thst inwoitau qdenam eyden oemgdirbm aeC h stkirowema rcfis arbuO
skico hyslpp uysen oemvitis o.Apdradna tdsl o nagyomono cnee plola m oasdteilp p,askcohs
fhoc aeesaerc noditetcide r stpdi in,an ugrn oe l hnktico tysen oe mhstesi atra he t nsdoaenifed
qeesu adclu okwco hysen oe mh,tlartu eenr eywen of.mItcap mnsioelbair aever hetht lau
(propor .tupt untoocef fohent in wugrn oe lhnstieci rd pnkaco tysen oe mhnstiesaerc n)ietanoit
is oAp nodata edllu od wn,an ugrn oe lhnttiupt usoesi atra he tnskoico hyslpp uesvit
seci rn putrro he shnttia hsttcide rlpe d .oe kmhcTo tysen oe mhnetisaerc nn iugrn o,lsuonegodne
ta het n sodaenif e sdkico hdsnam eed h,tyllan i.Fes idrlu okwco tysen oem hdt nlal adfluow
dessucs i sdeatanimreted n siticap mni utrro hss tdi n,akco tysen oem h nteisaerc n nisaesuac
.evoba
cap mdienibm o 8ce1 rearehT seziram m eu2lsb a.Tskco he shosttesnops en rugrn od lnta
rnooitazilam r sdoaae ns,udesop ms ianwoitcirts ee rhrtehte hswetacid nd insatcef fdeetcide repht
e rsanoitcn uefsnops eerslup mdietamit see h ft.Inoitcirts egrniyfitnedire v no sadae s eunbac

14 .kc olhes veecl idr lpds reaaoww eyeilbvla udqle ukocc oyhlsp pyues neohmT
8