International Gold Flows in Gold Standard Germany: A Test of the Monetary Approach to the Balance of Payments, 1880-1911: Note

Abstract

Arthur Bloomfield ( 1959) defined the rules of the game of the classical gold standard on the basis of the observed correlation between changes in domestic and foreign assets of the central bank. He argued that if the correlation were positive, the central bank was following the rules of the game because it reinforced the adjustment process set in motion by gold and foreign exchange flows by moving the domestic assets in the same direction. It did not follow the rules of the game if the observed correlation were negative, implying sterilization of reserve flows and a weakening of the adjustment process. Implicitly in Bloomfield's model the direction of causation runs from exogenous changes in foreign assets to endogenous changes in domestic assets. He found for a sample of gold standard central banks that domestic and foreign assets moved in the opposite direction in 60 percent of the observations, while they moved in the same direction in 34 percent of the observations and concluded that central banks did not follow the rules of the game at all times. The observed negative correlation is also consistent, however, with the direction of causation running mainly from changes in domestic assets to endogenously determined changes in foreign assets, as suggested by the monetary approach to the balance of payments.l This paper presents in section 1 a stylized model of the German monetary system during the gold standard. An equation is derived explaining international gold flows in the spirit of the monetary approach. Section 2 contains the esti-