NBER WORKING PAPER SERIES SEARCHING FOR IRVING FISHER. Kris James Mitchener Marc D. Weidenmier. Working Paper

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1 NBER WORKING PAPER SERIES SEARCHING FOR IRVING FISHER Kris James Michener Marc D. Weidenmier Working Paper hp:// NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachuses Avenue Cambridge, MA January 2010 We hank Michael Bordo, Richard Burdekin, Andy Rose, Eric Swanson, and paricipans a UC Berkeley, he San Francisco Fed, and he ASSA meeings for commens and suggesions. Michener acknowledges he generous financial suppor of he Hoover Insiuion while in residence as he W. Glenn Campbell and Ria Ricardo-Campbell Naional Fellow. The views expressed herein are hose of he auhors and do no necessarily reflec he views of he Naional Bureau of Economic Research. NBER working papers are circulaed for discussion and commen purposes. They have no been peerreviewed or been subjec o he review by he NBER Board of Direcors ha accompanies official NBER publicaions by Kris James Michener and Marc D. Weidenmier. All righs reserved. Shor secions of ex, no o exceed wo paragraphs, may be quoed wihou explici permission provided ha full credi, including noice, is given o he source.

2 Searching for Irving Fisher Kris James Michener and Marc D. Weidenmier NBER Working Paper No January 2010 JEL No. E4,G1,N2 ABSTRACT There is a long-sanding debae as o wheher he Fisher effec operaed during he classical gold sandard period. We break new ground on his quesion by developing a marke-based measure of general inflaion expecaions during he gold sandard. Since he gold-silver price raio was widely used o rack inflaion during he gold sandard period, we are able o derive a measure of inflaion expecaions using he ineres-rae differenial beween Ausrian silver and gold perpeuiy bonds wih idenical erms. Our empirical evidence suggess ha inflaion expecaions exhibied significan persisence a he weekly, monhly, and annual frequencies. We also find ha marke paricipans updaed long-run inflaion expecaions following shor-run changes in he forward silver price of gold. The evidence suggess he operaion of a long-run Fisher effec during he classical gold sandard period. Kris James Michener Deparmen of Economics Leavey School of Business Sana Clara Universiy Sana Clara, CA and NBER kmichener@scu.edu Marc D. Weidenmier Rober Day School of Economics and Finance Claremon McKenna College 500 Eas Ninh Sree Claremon, CA and NBER marc_weidenmier@claremonmckenna.edu

3 Searching for Irving Fisher Several sudies have found ha ex pos inflaion raes are uncorrelaed wih he level of nominal ineres raes during he classical gold sandard period even hough he Fisher equaion is an empirical relaionship based on inflaion expecaions. 1 One possible explanaion for he failure of he Fisher equaion in his earlier period is ha inflaion expecaions were nearly zero given he low level of persisence in annual measures of ex pos inflaion raes (Barsky, 1987; Bordo and Kydland, 1995; Fisher, 1930; Friedman and Schwarz, 1982). 2 Oher possible explanaions for he lack of correlaion beween nominal ineres raes and inflaion raes include he hypoheses ha financial markes had money illusion or ha invesors did no undersand he quaniy heory of money (Summers, 1983; Cagan, 1984; Choudry, 1996; Barsky and Delong, 1991). Several scholars have aemped o esimae price and inflaion expecaions during he gold sandard period o es for he presence of a Fisher effec using ime series economeric models (Capie, Mills, and Wood, 1991; Perez and Siegler, 2003). An obvious limiaion o his approach is ha we do no have a very good idea of he economic model ha marke paricipans used o form inflaion expecaions (Barsky and DeLong, 1988). Oher sudies have looked a he relaionship beween acual inflaion and nominal ineres raes o es for he presence of a Fisher effec. Summarizing he lieraure, McCallum (1984) poins ou ha sudies of pre-world War I changes in he 1 Many sudies have found ha nominal ineres raes during he gold sandard are correlaed wih he price level raher han he rae of inflaion. Barsky and Summers (1988) argue ha ha his posiive correlaion is a direc resul of he fac ha he price level in he inverse of he price of gold. Benjamin and Kochin (1984) argue ha Gibson s Paradox during his period is a spurious relaionship. 2 For a discussion of inflaion expecaions during he gold sandard period, see Barsky and DeLong (1983). For an analysis of he persisence of inflaion during he gold sandard period and laer, see Burdekin and Siklos (1996). Harley (1977) analyzes prices and ineres raes in he UK during he gold sandard period o es Gibson s Paradox. 1

4 price level have simply shown ha pas inflaion canno forecas fuure inflaion and herefore say very lile abou inflaion expecaions or he failure of he Fisher effec during he gold sandard period. 3 To break new ground on his issue, we collec high-frequency asse price daa ha allow us o compue a marke-based measure of inflaion expecaions for he 19 h cenury. In paricular, we use daa on Ausrian gold, silver, and paper governmen bonds o compue measures of inflaion expecaions a high and low frequencies during he classical gold sandard period and es for he presence of a long-run Fisher effec. Ausria was he only major European counry during he classical gold sandard period ha issued gold, paper, and silver perpeuiy bonds ha acively raded on he leading financial exchanges of Europe including London, Paris, Berlin, Amserdam and Vienna for mos of he gold sandard period, We use he ineres-rae differenial beween Ausrian silver and gold bonds o derive an ex ane marke-based measure of inflaion expecaions. Our use of he silvergold ineres-rae differenial is moivaed by he observaion ha he gold-silver price raio was a widely followed price. The Economis, for example, regularly repored on aciviy in he silver marke in heir weekly summary of financial markes. Moreover, we find evidence of a long-run coinegraing relaionship beween Ausrian silver and paper bonds. This suggess ha silver bonds are a good proxy for overall inflaion expecaions in Ausria. Our empirical analysis suggess ha inflaion expecaions were no a whie noise process during he gold sandard period. We find economically meaningful persisence in inflaion expecaions a he weekly, monhly, and annual frequencies. We hen es for 3 For an analysis of he Fisher effec during he pos-wwii period, see Mishkin (1981, 1992). 2

5 he presence of a Fisher effec by comparing our measure of inflaion expecaions compued from Ausrian bonds wih a shor-run measure of inflaion expecaions calculaed from he spo and fuures marke for he silver price of serling (gold). We show ha shor-run changes in inflaion expecaions Granger-cause long-run inflaion expecaions. We inerpre our findings as evidence of he operaion of a Fisher effec during he classical gold sandard period. The nex secion of he paper discusses our daa on Ausrian bonds during he classical gold sandard period. In secion III, we analyze he ime series properies of inflaion expecaions during our sample period in Ausria and hen es for a long-run Fisher effec. The las secion discusses our findings and heir implicaions. II. Ausria and he Gold Sandard To derive a marke-based measure of inflaion expecaions and o es for he presence of a Fisher effec during he gold sandard period, we assembled a new daabase of weekly prices of Ausrian gold, silver, and paper sovereign deb issues over he period using bond quoaions from he Economis. 4 Ausria apped inernaional capial markes on a significan scale following he passage of he Law of March 16, 1876, which auhorized a 16 million florin bond issue ha was exemp from Ausrian axes and paid ineres half-year in gold in Vienna and oher European exchanges including Amserdam, Berlin, Brussels, Frankfur, and Paris. Morys (2008) esimaed ha foreigners held approximaely 80 percen of he deb issue. In 1910, he Sock Exchange 4 The Economis and The Times sopped quoing prices for Ausrian paper bonds in

6 Official Inelligence repored ha here were more han 490 million Ausrian Kroner gold bonds unredeemed ha raded on markes hroughou Europe. Ausria also issued silver bonds on he leading European exchanges. Issued in 1868, he bonds were perpeuiy obligaions and subjec o a 16 percen income ax. The coupon paymens on he fiver percen silver bonds were payable half-yearly on February or Augus 1 s or on May 1 s and November 1 s (Sock Exchange Official Inelligence, various issues). There was approximaely 519 million Kroner of ousanding silver bonds in Finally, Ausria issued floaed large amouns of governmen deb hroughou Europe in is own currency. Iniially issued in he lae 1860s, he paper bonds were perpeuiy obligaions and subjec o a 16 percen income ax. The coupon paymens on he paper bonds were payable half-yearly on February or Augus 1 s or on May 1 s and November 1 s (Sock Exchange Official Inelligence, various issues). Like he silver bonds, he paper deb did no conain a sinking-fund and had a five percen coupon. The marke value of unredeemed paper bonds exceeded more han 886 million Kroner in Morys (2008) finds ha approximaely 20 percen of he paper bonds were held by foreign invesors. Only he UK, France, Germany, Neherlands, and he Unied Saes were also able o sell large bond issues in heir home currency on several European markes during he classical gold sandard period. Some scholars have characerized nineeenh-cenury Ausria as a financially underdeveloped, agriculurally-oriened economy, suggesing ha i belonged o he periphery raher han o he core of European gold sandard counries like he Unied Kingdom, France, or Germany. However, he fac ha Ausria was able o issue paper 4

7 deb successfully hroughou Europe suggess ha i may have more closely resembled a core gold sandard counry. In conras o counries on he periphery, Ausria suffered original sin only o he exen ha is deb was denominaed in gold, silver, and paper florin (Eichengreen and Hausmann, 1999; Bordo, Meissner, and Redish, 2005). A depreciaion in he paper florin, for example, would require Ausrian auhoriies o collec more ax revenues (in paper florin) o service is deb denominaed in gold florin. 5 In addiion, Ausria s sandard of living prior o World War I compares favorably o oher core gold sandard counries, such as France and Germany (see Figure 1). Furher, Ausria was one of he leading European miliary powers of he lae nineeenh cenury and is financial markes appear o have been well developed and inegraed (Good, 1977). An inegraed nework of join sock banks wih an exensive branching sysem (including he imporan Viennese banks) emerged in he 19 h cenury o lend o businesses hroughou he Ausrian empire. Furher, Ausria borrowed from he German model of universal banking in forming insiuions such as he Crediansal fur Handel und Gewerbe (1855), and i creaed a cenral bank in 1816, modeled afer he Bank of France, which had he exclusive righ o issue noes. The issuance of sovereign deb denominaed in gold, silver, and paper is also parly a funcion of is moneary hisory. Ausria was on he silver sandard for much of he nineeenh cenury, bu like many oher counries, wen ono he gold owards he end of he cenury. The Compromise of 1867 beween Ausria and Hungary gave consiuional foundaions for a moneary union wih he silver florin as he moneary sandard and a cenral bank wih no auhoriy o prin new currency issues. Despie his 5 This was rue even afer Ausria joined he gold sandard. As shown in he Amserdamsch Effecenblad, afer Ausria joined he gold sandard, he coupons for paper bonds ofen raded a a discoun o he coupons for gold bonds. 5

8 agreemen, Ausria and Hungary disagreed over he managemen of moneary policy. In addiion o a moneary union, Hungary waned overdraf faciliies and a cenral bank office in Budapes. In July 1878, Ausria and Hungary renewed he Compromise of 1867 for en years, bu changed he name of he cenral bank from he Ausrian Naional Bank o he Ausro-Hungarian Bank. This new agreemen creaed cenral bank offices in Budapes and Vienna wih boh German and Hungarian as he official languages of he moneary insiuion. Bu afer 1879, he florin was no longer converible ino silver. The exchange-rae sysem hen began o resemble a floa more han a peg. Silver florin raded for as much as seven percen from he min par raio and, as shown in Figure 2, exchange raes exhibied significan flucuaions in he 1880s. Ausria hen joined he gold sandard in Augus 1892 afer renewing he Compromise wih Hungary for a second ime. A his poin, i also esablished he kronen (crown) as is new currency. The kronen s value was fixed in erms of gold and complee conrol of he money supply was given o he cenral bank. The credibiliy of his new moneary regime was furher buressed in 1899 when Hungary was graned full pariy wih Ausria in he managemen of he cenral bank. Invesors reaced favorably o his new power-sharing arrangemen: large capial inflows from he leading European financial ceners including London, Paris, and Berlin occurred in response (Tullio and Wolers, 2007). Flandreau and Komlos (2001) argue ha even hough Ausria never formally esablished gold converibiliy prior o World War I, he counry was a de faco member of he gold sandard by 1896 because of he sabiliy of is exchange rae. For example, Tullio and Wolers (2007) show ha he Ausrian exchange rae vis-à-vis oher major 6

9 gold sandard counries (England, France, and Germany) flucuaed wihin a range of abou 15 percen beween 1876 and 1891 and jus eigh percen beween 1892 and The share of meallic-backed noes o paper noes issued by he cenral bank increased from an average of 53 percen over he period o an average of nearly 75 percen over he period (Tullio and Wolers, 2007). Afer 1896, he exchange rae for he Ausrian crown relaive o oher gold sandard counries flucuaed only wo percen and +/- 0.4 percen from min par (Flandreau and Komlos, 2001; Tullio and Wolers, 2007). Figure 2 confirms ha Ausrian exchange raes were remarkably sable afer he counry joined he gold sandard. Based on he behavior of he exchange rae, Flandreau and Komlos (2001) conclude ha Ausria was a counry ha was neiher a core nor a peripheral member of he gold sandard, bu raher somewhere in beween. III. Empirical Analysis of he Fisher Effec A. Model and Esimaing Inflaion Expecaions The Fisher equaion saes ha he nominal ineres raes on a given sovereign deb obligaion is equal o he real ineres rae plus he expeced rae of inflaion. The nominal ineres rae for Ausrian silver bonds can herefore be wrien as: S e,s (1) i = r + π, where r is he real ineres rae and π e, S he Fisher equaion for Ausrian gold bonds is: G e,g (2) i = r + π. is he expeced rae of silver inflaion. Likewise, 7

10 e Inflaion expecaions for he gold bond are denoed by π, G. The silver-gold ineres-rae differenial can be obained by subracing equaion (2) from equaion (1), which yields: (3) S G i i = π. e, S G Equaion (3) saes ha he silver-gold ineres rae spread is equal o he expeced rae of inflaion in he silver-gold price raio. To carry ou our empirical analysis, we make hree assumpions abou he bonds and invesor behavior: (1) invesors are risk-neural; (2) he real ineres rae is he same for boh bonds given ha he Ausrian governmen issued he wo deb obligaions; and (3) silver and gold bonds have idenical defaul risk. The hird assumpion of idenical defaul risk appears reasonable since Ausria faihfully repaid is sovereign deb beween 1880 and Given ha he silver and gold bonds were widely held by foreign invesors, Ausria could no differenially defaul on he silver bonds wihou damaging is repuaion in inernaional capial markes. Even if here were some differenial defaul risk beween silver and gold bonds, he premium is no likely large enough o have a qualiaive impac on our analysis. Figure 3 plos curren yields on a weekly basis for he Ausrian gold, silver, and paper bonds from January 1880 o April The hree series end o move ogeher, wih he gold bond having he lowes ineres rae over he course of he sample period. As shown in Table 1, he average ineres rae for Ausrian gold bonds during he gold sandard period is abou 430 basis poins wih a sandard deviaion of 39 basis poins. The ineres rae on silver deb averaged approximaely 555 basis poins wih a sandard deviaion of 61 basis poins. The average ineres rae for paper bonds over he enire sample period was 559 basis poins wih a sandard deviaion of 63 basis poins. Bond 8

11 yields were highes during he silver sandard for hese hree deb issues. Following he adopion of he gold sandard, he average yield for he gold bonds fell by approximaely 60 basis poins and more han 100 basis poins for he silver bonds. Figure 3 shows ha he ineres raes on silver and paper bonds are nearly idenical and he wo series may conain a common sochasic rend.. We employ he Engle-Granger wo-sep procedure o es for coinegraion beween paper and silver bonds. The λ MAX saisic of suggess ha he null hypohesis of no coinegraion can be rejeced a convenional levels of significance. 6 We find even sronger resuls when Ausria was a de jure member of he gold sandard ( ) or for he period from 1896 o 1911 when Ausria was de faco on he gold sandard and he Ausrian exchange rae exhibied very small flucuaions away from min par. Using eiher of he de jure or de faco sar dae for Ausria s adopion of he gold sandard, we are unable o rejec he null hypohesis ha he paper and silver bonds share he same sochasic rend. This finding suggess ha he silver-gold ineres rae differenial is no only a measure of inflaion expecaions in he relaive price of silver and price, bu i is also a measure of overall inflaion expecaions in he Ausrian economy. The silver-gold price raio was widely quoed in he financial press as an imporan indicaor of inflaion during he enire gold sandard period. Consider he following an excerp from a manufacurer o he Edior of he Economis: The grea even of he las few weeks has been he rise in silver [price of gold]. I is he supposed cause of a considerable rise in he prices of many commodiies, and if he predicions of bi-mealliss are worh anyhing, i ough o have grealy improved he posiion of he coon spinner and manufacurer. (Economis, May 24, 1890, p. 665) 6 We are also able o rejec he null of no coinegraion using he Johansen coinegraion es. 9

12 Prof. J.S. Nicholson, quoed in he Economis, noed ha he fall in he gold price of silver has coincided almos exacly wih he fall of he gold prices of commodiies in general (Economis, February 10, 1894, p.171). Since consumer price indexes or wholesale price indexes were no ye widely available o invesors and marke paricipans, hey relied on informaion from he silver price of gold o form expecaions abou he broader movemens in prices. Figure 4 plos our weekly measure of inflaion expecaions, π e, S G, alongside weekly curren yields for Ausrian paper-bonds for he period January 1880 o April The simple correlaion coefficien beween paper ineres raes and inflaion expecaions is approximaely 40 percen. Inflaion expecaions over he enire sample period averaged 1.25 percen (125) basis poins and accouned for approximaely 22 percen of he nominal ineres rae (inflaion expecaions/nominal ineres rae). Since inflaion expecaions were relaively sable (he sandard deviaion is less han hree percen), he empirical evidence also indicaes, as suggesed by Shiller and Siegel (1977), ha movemens in real ineres raes were probably more imporan han inflaion expecaions in driving flucuaions in Ausrian nominal ineres raes. B. Persisence of Inflaion Expecaions To examine he ime-series properies of long-run inflaion expecaions during he classical gold sandard period, we firs es for a uni roo using he Augmened Dickey-Fuller-GLS es. The null hypohesis of a uni roo can be rejeced a he one- 10

13 percen level of significance. 7 To measure he persisence of inflaion expecaions, we esimaed ARIMA models for he enire sample period as well as he periods when Ausria was a member of he silver and gold sandards. As shown in Table 2, inflaion expecaions in Ausria are bes characerized by an AR(3) process over he enire sample period. The sum of he auoregressive coefficiens is over 97 percen, which indicaes a high degree of persisence in inflaion expecaions. The consan indicaes ha invesors expeced inflaion expecaions of approximaely 1.23 percen per year. For he silver sandard period, we also find a high degree of persisence. Inflaion expecaions are bes characerized by an AR(2) process. The sum of he auoregressive coefficiens during he silver sandard period is over 97 percen. The coefficien on he consan erm in he equaion suggess ha financial marke paricipans expeced inflaion o average approximaely 1.51 percen per year. For he gold sandard period, we esimae ARIMA models from Augus 1892 o April 1911, and find ha he bes model for inflaion expecaions is an AR(2) model. Table 2 shows ha he level of inflaion persisence drops o abou 94 percen. Alhough we observe a slighly lower level of persisence in inflaion expecaions afer Ausria joined he gold sandard, here is a marked reducion in he average level of inflaion expecaions from 1.51 percen o 1.06 percen. These findings sugges ha here was significan persisence in inflaion expecaions and ha joining gold reduced he average level of inflaion expecaions by roughly 30 percen. One possible criique our analysis hus far is ha he large persisence in inflaion expecaions may be driven by he use of high frequency daa in he esimaion process. 7 We experimened wih lag lenghs of 1 o 12 for he uni roo ess. In all cases, we were able o rejec he null hypohesis of a uni roo a he five percen level of significance. 11

14 We herefore re-esimaed he baseline empirical resuls using end-of-monh daa. The ARIMA models of monhly inflaion expecaions are presened in Table 3. The resuls are similar o hose employing he weekly daa. Inflaion expecaions followed an AR(1) process when he counry adhered o he silver sandard and inflaion persisence is greaer han 90 percen and significan a he one-percen level. For he gold sandard period, inflaion expecaions are bes modeled as an AR(1) process. Alhough inflaion expecaions are once again no a whie noise process, he coefficien on he auoregressive erm falls by roughly 12 percen, from 95 o 83 percen. Using annual daa, we find similar resuls for he persisence of inflaion. The consan erm shown in Table 4 indicaes ha annual inflaion expecaions averaged more han one percen over he full sample period. Again, we find ha here is significan persisence in inflaion expecaions: he sum of he wo auoregressive erms is nearly 90 percen. Hence, using weekly, monhly, or annual daa, we find subsanial persisence in inflaion expecaions during he gold sandard period as measured by he silver-gold ineres rae differenial. Anoher possible criique of our analysis is ha Ausria s commimen o gold migh have been perceived as less credible han oher wesern European counries, and hence he analysis of inflaion expecaions we derive for i may no be very represenaive of gold club members. Tha is, inflaion expecaions for non-credible members of he gold sandard may be much larger han for counries ha sricly adhered o he moneary rule. While Ausria was a newer member of he gold sandard in comparison o France, Germany, and he UK, i does no appear ha marke paricipans viewed is commimen o gold as subsanially less credible han hese counries. 12

15 Michener and Weidenmier (2008) provide evidence ha Ausria was one of he mos credible gold sandard moneary regimes during he period : marke paricipans expeced he Ausrian kroner o depreciae approximaely hree percen afer he counry joined he gold sandard based on he premium of paper over gold bonds. The level of expeced depreciaion is considerably smaller han several oher gold sandard counries including he Unied Saes, Argenina, Brazil, Chile, India, Mexico, and Russia. We herefore inerpre our resuls as providing a lower bound on he size and persisence of inflaion expecaions for he average core counry during he classical gold sandard period. C. Tesing for a Long-Run Fisher Effec We now provide a sraighforward es of he long-run Fisher effec s operaion during he classical gold sandard era. We analyze he relaionship beween he 60-day forward and spo silver price of gold and our measure of inflaion expecaions based on ineres rae spreads. The forward marke for silver began operaion in he early 1890s, so we colleced weekly a new daa se on silver prices from conemporaneous newspapers. The Mancheser Guardian began regularly reporing daa on 60-day forward silver conracs in March 1894 while he Economis began reporing on he silver marke in January We use he spo and forward silver price of gold (as expressed in pound serling) o compue an annual measure of shor-run inflaion expecaions for he period March 17, 1894 o April 28,

16 Our measure of shor-run inflaion expecaions (assuming ha invenory coss are consan over ime) can be wrien as: π e, SR F s s = 60,000* s, (4) e where π, SR are inflaion expecaions, F s is he 60-day forward silver price, and s is he spo silver price of serling (gold). The righ hand side of equaion (4) is muliplied by 60,000 (=6*100*100) o conver inflaion expecaions ino an annual measure expressed in basis poins. The shor-run measure of inflaion expecaions compued from he silver spo and forward markes averaged -170 basis poins wih a sandard deviaion of 487 basis poins over he enire sample period. Figure 5 shows our shor and long-run measures of inflaion expecaions. The shor-run measure of inflaion expecaions is significanly more volaile han he long-run measure of inflaion expecaions. We esimae Granger causaliy ess o examine he relaionship beween our shor-run and long-run measures of inflaion expecaions. We firs es he shor-run measure of inflaion expecaions using he Augmened Dickey-Fuller-GLS es. The null hypohesis of a uni roo can be rejeced a he five-percen level of significance. We hen esimae Granger causaliy ess for he enire sample period for which we have daa on he silver forward marke. A lag lengh of 18 weeks is chosen for he empirical analysis based on he Akaike Informaion Crieria (AIC). 8 The empirical resuls are presened in Table 5. Our shor-run measure of inflaion expecaions Granger causes he ineres-rae differenial beween silver and gold bonds a he one-percen level of significance. This suggess ha marke paricipans updaed long-run inflaion expecaions based on 8 We considered lag lenghs up o 26 weeks (half a year) for he empirical analysis. 14

17 changes in shor-run inflaion expecaions. The resul is consisen wih recen research, which has found ha long-erm US governmen bonds respond o shor-run macroeconomic and financial surprises (Gürkaynak e. al, 2005). On oher hand, we do no find evidence ha our long-run measure of inflaion expecaions Granger causes changes in shor-run inflaion expecaions. This is no very surprising given ha long-run inflaion expecaions largely reflec informaion over a longer ime horizon han 60 days. We follow-up he Granger-causaliy ess wih an impulse response analysis, and give he forward/spo silver marke he second ordering in he Choleski decomposiion. By placing silver second in he ordering, we provide a lower-bound esimae of he impac of a one-sandard deviaion shock of shor-run inflaion expecaions on long-run inflaion expecaions (measured by ineres rae differenial). Figure 6 shows ha a onesandard deviaion shock o shor-run inflaion expecaions increases long-run inflaion expecaions by 30 basis poins over wo years (cumulaive impulse response). As he graph indicaes, he impulse response is saisically differen from zero (a he 95 percen confidence level) from abou he 25 o 70 week horizon. The resul implies ha a depreciaion in silver (i.e. an increase in shor-run silver inflaion expecaions) increases he Ausrian silver-gold ineres rae differenial. As a robusness check, we also esimae he relaionship beween long and shorrun inflaion expecaions over he de faco gold sandard period 1896 o April As Table 6 shows, we also find ha shor-run inflaion expecaions Granger-cause long-run inflaion expecaions over his sample period, bu no vice-versa. Impulse response funcions for he period 1896-April 1911 are shown in Figure 7. As he figure indicaes, a 15

18 shock o shor-run silver inflaion expecaions increases long-run inflaion expecaions by more han 28 basis poins over wo years. V. Conclusions Macroeconomiss and economic hisorians have long searched for he operaion of Irving Fisher s eponymous effec during he classical gold sandard period. We show ha Fisher and his effec may be lurking in he inflaion expecaions of Ausrian sovereign deb issues of he 19 h cenury. We compue one of he firs, high-frequency marke-based measures of general inflaion expecaions for he classical gold sandard period so ha we can es for he presence of he Fisher effec. Previous sudies have used gold bonds and economeric models o examine he relaionship beween nominal ineres raes and inflaion. We believe ha our measure, he ineres rae differenial beween silver and gold bonds, provides a more direc approach for sudying he behavior of long-run inflaion expecaions during he gold sandard period. Our measure is moivaed by he fac ha he gold-silver price raio was widely followed by conemporary marke paricipans and he fac ha our measure of inflaion expecaions does no rely on modern economeric ools and sofware o calculae. Our analysis of inflaion expecaions, proxied by he ineres rae differenial beween silver and gold bonds, suggess several conclusions. Firs, he adopion of he gold sandard reduced he average level of inflaion expecaions in Ausria. Joining he gold sandard led o a 30 percen drop in inflaion expecaions, from 1.5 percen o 1.1 percen, as measured by decisions made in financial markes. We also find ha here is 16

19 considerable persisence in long-run inflaion expecaions a he weekly, monhly, and annual frequencies. The empirical analysis suggess he presence of a Fisher effec given ha changes in inflaion expecaions compued from he forward marke for silver Granger cause movemens in he Ausrian ineres-rae differenial beween silver and gold bonds. Marke paricipans updaed long-run inflaion expecaions following shorrun changes in he fuure silver price of gold. Invesors during he classical gold sandard period required an inflaion premium ha was buil ino nominal ineres raes as long as he deb obligaion was denominaed in silver or paper raher han gold. 17

20 References Barsky, Rober B. (1987). The Fisher Hypohesis and he Forecasabiliy and Persisence of Inflaion. Journal of Moneary Economics 19(1): Barsky, Rober B. and J. Bradford Delong. (1991). Forecasing Pre-World War I Inflaion: The Fisher Effec and he Gold Sandard. Quarerly Journal of Economics 106(3): Barsky, Rober B. and Lawrence H. Summers. (1988). Gibson s Paradox and he Gold Sandard. Journal of Poliical Economy 96(3): Benjamin, Daniel and Levis Kochin. (1984). War, Prices, and Ineres Raes: A Marial Soluion o Gibson s Paradox. in, A Resrospecive on he Classical Gold Sandard, (Michael Bordo and Anna Schwarz, eds.), Bordo, Michael and Finn Kydland. (1995). The Gold Sandard as a Rule: An Essay in Exploraion. Exploraions in Economic Hisory 32(4): Bordo, Michael, Chrisopher Meissner, and Angela Redish. (2005). How Original Sin was Overcome: The Evoluion of Exernal Deb Denominaed in Domesic Currencies in he Unied Saes and he Briish Dominions In Oher People s Money: Deb Denominaion and Financial Insabiliy in Emerging Marke Economies, Barry Eichengreen and Ricardo Hausmann (eds.), Chicago: Universiy of Chicago Press, pp Bordo, Michael and Anna Schwarz. (1981). Money and Prices in he Nineeenh Cenury: Was Thomas Tooke Righ? Exploraions in Economic Hisory 18: Burdekin, Richard C.K. and Pierre Siklos. (1996). Exchange Rae Regimes and Shifs in Inflaion Persisence: Does Nohing Else Maer? Journal of Money, Credi, and Banking 31(2): Cagan, Philip. (1984). Mr. Gibson s Paradox: Was I There? A Resrospecive on he Classical Gold Sandard, (Michael Bordo and Anna Schwarz, eds.), Capie, Forres H., Terrence C. Mills, and Geoffrey E. Wood. (1991). Money, ineres raes, and he Grea Depression: Briain from 1870 o 1913, in New Persepecives on he lae Vicorian Economy (James Foreman-Peck, ed.), Choudry, Tafiq. (1996). The Fisher Effec and he Gold Sandard: Evidence from he USA. Applied Economic Leers 3(8): Economis, various issues. 18

21 Eichengreen, Barry and Ricardo Hausmann. (1999). Exchange Raes and Financial Fragiliy. NBER Working Paper Fisher, Irving (1930). The Theory of Ineres. New York, NY: Macmillan. Flandreau, Marc and John Komlos (2001). Core or Periphery? The Credibiliy of he Ausro-Hungarian Currency. CEPR Working Paper. Flandreau, Marc and Frederic Zumer (2004). The Making of Global Finance. Paris: OECD. Friedman, Milon and Anna J. Schwarz. (1982). Moneary Trends in he Unied Saes and he Unied Kingdom, Their Relaion o Income, Prices, and Ineres Raes, Chicago, IL: Universiy of Chicago Press. Good, David F. (1977). Financial Inegraion in Lae Nineeenh Cenury Ausria. Journal of Economic Hisory. 37(4): Gürkaynak, Refe, Sack, Brian, and Eric Swanson. (2005). The Sensiiviy of Long- Term Ineres Raes o Economic News: Evidence and Implicaions for Macroeconomic Models. American Economic Review 95(1): Harley, C. Knick. (1977). The Ineres Rae and Prices in Briain, : A Sudy of he Gibson Paradox. Exploraions in Economic Hisory 14(January): McCallum, Benne (1984). On Low-Frequency Esimaes of Long-Run Relaionships in Macroeconomics. Journal of Moneary Economics 14(1): Mishkin, Frederic S. (1981). The Real Ineres Rae: An Empirical Invesigaion. Carnegie-Rocheser Conference Series on Public Policy 15: Mishkin, Frederic S. (1992). Is he Fisher Effec for Real? A Reexaminaion of he Relaionship beween Inflaion and Ineres Raes. Journal of Moneary Economics 30(2): Michener, Kris and Marc D. Weidenmier (2008). Are Hard Pegs Ever Credible in Emerging Markes? NBER Working Paper # Morys, Mahias. (2008). The Classical Gold Sandard in he European Periphery: A Case Sudy of Ausria-Hungary and Ialy, Unpublished Docoral Disseraion, London School of Economics and Poliical Science. Perez, Sephen and Mark Siegler. (2003). Inflaionary Expecaions and he Fisher Effec prior Pre World War I. Journal of Money, Credi, and Banking 35(6):

22 Shiller, Rober and Jeremy Siegel. (1977). The Gibson Paradox and Hisorical Movemens in Real Ineres Raes. Journal of Poliical Economy 85(5): Sock Exchange Official Inelligence, Various Issues. Summers, Lawrence H. (1983). The Nonadjusmen of Nominal Ineres Raes. In Macroeconomics, Prices, and Quaniies, edied by James Tobin. Washingon, DC: Brookings Insiue, pp The Times of London, various issues. Tullio, Giusseppe and Jurgen Wolers. (2007). Moneary Policy in Ausria-Hungary, : An Economeric Analysis of he Deerminans of he Cenral Bank s Discoun Rae and he Liquidiy Raio. Open Economies Review 18 (Ocober):

23 Table 1. Mean Ausrian Ineres Raes, 1880-April 1911 (Basis Poins) Whole Period (Sd. Deviaion) Gold (38.572) Silver (61.265) Paper (63.685) Gold Sandard (Sd. Deviaion) (10.064) (13.015) (13.224) Silver Sandard (Sd. Deviaion) (36.168) (45.470) (48.681) Table 2. ARIMA Models of Inflaion Expecaions(Weekly Daa) Whole Period Silver Sandard Gold Sandard Consan *** (11.300) *** (12.393) *** (1.689) AR(1) 0.791*** (0.025) 0.772*** (0.038) 0.855*** (0.032) AR(2) 0.141*** (0.031) 0.206*** (0.038) 0.084*** (0.032) AR(3) 0.057** (0.025) Observaions * significan a 10%; ** significan a 5%; *** significan a 1% Table 3. ARIMA Models of Inflaion Expecaions (Monhly Daa) Whole Period Silver Sandard Gold Sandard Consan *** *** *** (12.809) (15.430) AR(1) 0.971*** 0.948*** (0.012) (0.028) AR(2) AR(3) Observaions * significan a 10%; ** significan a 5%; *** significan a 1% (1.92) 0.830*** (0.037) 21

24 Table 4. ARIMA Models of Inflaion Expecaions (Annual Daa) Whole Period Consan *** (14.257) AR(1) 1.485*** (0.153) AR(2) 0.608*** (0.154) Observaions 30 * significan a 10%; ** significan a 5%; *** significan a 1% Table 5 Long-Term Fisher Effec Granger Causaliy Tess (F-ess) Granger Causaliy Tes F-es e, SR e, S G Shor-run( π ) Long-Run( π ) *** e Long-run ( π, S G e, SR ) Shor-Run( π ) * significan a 10%; ** significan a 5%; *** significan a 1% Table 6 Long-Term Fisher Effec Granger Causaliy Tess (F-ess) Granger Causaliy Tes F-es e, SR e, S G Shor-run( π ) Long-Run( π ) *** e Long-run ( π, S G e, SR ) Shor-Run( π ) * significan a 10%; ** significan a 5%; *** significan a 1% 22

25 6,000 5,000 4,000 3,000 2,000 1,000 0 Figure 1 GDP Per Capia, Source: Maddison Yearly Inervals Ausria France Germany UK GDP Per Capia

26 Figure 2 Franco-Ausrian Exchange Rae Source: Flandreau and Zumer (2004) Annual Inervals

27 Figure 3 Ausrian Gold, Silver, and Paper Bonds, 1880-April 1911 (Basis Poins) 3-Jan-80 3-Jan-81 3-Jan-82 3-Jan-83 3-Jan-84 3-Jan-85 3-Jan-86 3-Jan-87 3-Jan-88 3-Jan-89 3-Jan-90 3-Jan-91 3-Jan-92 3-Jan-93 3-Jan-94 3-Jan-95 3-Jan-96 3-Jan-97 3-Jan-98 3-Jan-99 3-Jan-00 3-Jan-01 3-Jan-02 3-Jan-03 3-Jan-04 3-Jan-05 3-Jan-06 3-Jan-07 3-Jan-08 3-Jan-09 3-Jan-10 3-Jan-11 Weekly Inervals gold silver paper

28 Figure 4 Ausrian Inflaion Expecaions and Nominal (Paper) Ineres Raes, 1880-April 1911 (Basis Poins) 3-Jan-80 3-Jan-82 3-Jan-84 3-Jan-86 3-Jan-88 3-Jan-90 3-Jan-92 3-Jan-94 3-Jan-96 3-Jan-98 3-Jan-00 3-Jan-02 3-Jan-04 3-Jan-06 3-Jan-08 3-Jan-10 Weekly Inervals Inflaion Expecaions Paper Ineres Raes

29 Figure 5 Long and Shor-Run Inflaion Expecaions March 1894-April 1911 (Basis Poins) 3/17/94 3/17/95 3/17/96 3/17/97 3/17/98 3/17/99 3/17/00 3/17/01 3/17/02 3/17/03 3/17/04 3/17/05 3/17/06 3/17/07 3/17/08 3/17/09 3/17/10 3/17/11 Weekly Inervals Long-Run Shor-Run Long-Run Inflaion Expecaions (Basis Poins) Shor-Run Inflaion Expecaions (Basis Poins)

30 Figure 6 Response of Long-Run Inflaion Expecaions o a One-Sandard Deviaion Shock o Shor-Run Inflaion Expecaaions (95% Confidence Inervals) Basis Poins Weeks

31 Figure 7 Response of Long-Run Inflaion Expecaions o a One-Sandard Deviaion Shock o Shor-Run Inflaion Expecaaions (95% Confidence Inervals) Basis Poins Weeks