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How did the U.S. economy perform under the pre-Fed gold standard?

The Federal Reserve System, established in 1914, recently marked its 100th anniversary. Every so often, someone expresses a longing for the “good old days” when the United States had no central bank and the dollar was anchored to the gold standard. Under a gold standard, the government promises to exchange its currency for gold at a fixed price; proponents argue that this prevents the government from printing money to finance expenditures, which could be inflationary. So, mainly the supply of gold, and not central bank policy or government spending, determines the value of the nation’s money.

The United States suspended the gold standard during the Civil War, but the Resumption Act of 1875 led to our return to the gold standard in 1879. The gold standard lasted through the creation of the Fed, loosened somewhat during the Great Depression, and eventually was abandoned in 1971.

How did the U.S. economy perform under the gold standard before the Fed was established? I turned to data in the NBER Macrohistory Database to find out.

The first graph plots the U.S. monetary gold stock and an index of the general level of prices from June 1878 to Dec. 1914. (The shaded areas indicate U.S. recessions.) Changes in the size of the gold stock were caused by additions to world gold supply (mainly from mining) and to gold flows associated with payments for international trade and investment. Over much of this period, especially after major gold discoveries increased world supplies in the 1890s, the monetary gold stock rose and the U.S. price level rose in response. However, over shorter periods of one to two years, the relationship between the size of the gold stock and the price level was not so close. For example, the price level rose sharply in the early 1880s and then abruptly declined, despite a smoothly rising gold stock.

The second graph shows the volatility of the price level during this period by plotting the year-over-year percent change in the price level (i.e., the inflation rate) alongside the gold stock. We can see the inflation rate fluctuated widely in this period, from about -10% in some years to about +10% in others. Over most of the period, the average inflation rate was low—close to zero—but the annual fluctuations in the rate were large, much larger than they have been in the United States in recent years. This price index for the 19th and early 20th centuries was constructed using different methods and with less information and precision than current price indexes use, which must be kept in mind when making comparisons between the pre-Fed era and modern times. However, beyond the volatility in the rate of inflation, the pre-Fed era was marked by several recessions, as well as serious banking panics and other financial crises. Thus, the historical evidence indicates that neither a gold standard nor the absence of a central bank guarantees economic or financial stability.

How these graphs were created: The “Academic Data” section of FRED contains data series constructed or contributed by academics and other non-official sources. The NBER Macrohistory Database includes historical series collected by researchers at the NBER and others. For these graphs, find the series “Monetary Gold Stock for United States” in the NBER Macrohistory Database under the subcategory “Money and Banking” or by using the tag “gold.” Select the range 1878-1914. Add the “Index of the General Price Level for United States” series to the graph (from the same database) and assign this series to the right y-axis in the “edit data series” window. For the second graph, simply change the units of the price level series to “Percent change from year ago.”

Suggested by David Wheelock.

View on FRED, series used in this post: M04051USM324NNBR, M1476AUSM027NNBR