HIAS-E-75

The Political Economy of Exchange Rate Stability During theGold Standard. Spain 1874—1914
Elena Martı́nez-Ruiz(a) and Pilar Nogues-Marco(b)(a) University of Alcalá, Madrid(b) University of Geneva and CEPR

September, 2018

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1

THE POLITICAL ECONOMY OF EXCHANGE RATE STABILITYDURING THE GOLD STANDARD. SPAIN 1874-1914♦

Elena MARTÍNEZ-RUIZ
University of Alcalá, Madrid
elena.martinez@uah.es

Pilar NOGUES-MARCO
University of Geneva and CEPR
pilar.noguesmarco@unige.ch

This draft, June 2018

Abstract
This article contributes to the literature on central bank independence and monetary stability
during the classical gold standard era. On the eve of the First World War, European periphery
had not achieved stable adherence to gold despite the protection of central banks against
political pressures to monetize debt. In the 19th century, most issuing institutions were privatebanks whose main objective was profit maximization. As a result, monetary stability depended
on negotiations between monetary and fiscal authorities and not directly on central bankindependence as is the case nowadays. Strong governments were needed to impose theobjective of monetary stability on central banks in negotiation practices. To test our argument,
we have constructed indicators of government strength and central bank independence tomeasure bargaining power for the case of Spain. Results confirm that a highly independent
private central bank avoided the responsibility of defending gold adherence when negotiatingwith weak government, even in a stable macroeconomic environment. Our research suggeststhat the success of central bank independence in generating monetary stability during the gold
standard period depended on sound political institutions.

Keywords: gold standard, monetary stability, political economy, central bank independence,
institutional design, Spain
JEL codes: E02, E42, E58, F33, N13

Elena Martínez-Ruiz and Pilar Nogues-Marco acknowledge Spanish government support through Projects
ECO2012-33337 (MINECO) and ECO2015-66782-P (MINECO/FEDER). The authors wish to thank participants in the
Iberometrics Conference (Zaragoza, May 2013), the AEHE Conference (Madrid, Sept 2014), the UC3M Workshop(Madrid, Dec 2014), the EHES Conference (Pisa, Sep 2015), the Paul Bairoch Institute Workshop (Geneva, May 2016)
and the Fresh Meeting (Geneva, June 2016), as well as Sebastian Alvarez, Rafael Dobado, Marc Flandreau, Juan
Flores, Pablo Martín-Aceña, Miguel Martorell, Didac Queralt, Alejandro Requejo and Peter Temin for their usefulcomments. The authors are also grateful for cooperation from archivists and librarians in the Bank of Spain Archiveand the Madrid Stock Exchange Library. Elena Martínez-Ruiz ORCID 0000-0001-9464-1164. Pilar Nogues-Marco (ThePaul Bairoch Institute of Economic History) ORCID 0000-0003-1164-519X♦

2Introduction
Economic theory states that central bank independence generates monetary stability. Lévy
(1911) already asserted that central bank independence was a prerequisite for monetarystability because the separation of the central bank from the state prevented debt
monetization (Flandreau et al. 1998). This theory on fiscal dominance was formalized bySargent and Wallace (1981): the central bank's objective is monetary stability, but the fiscal
authority puts pressure on the central bank to monetize fiscal deficits. Therefore, fiscal deficits
are the source of inflation. In this context, central bank independence ensures fiscal
responsibility and avoids all excessive use of the inflation tax.
A second theoretical approach that supported the relationship between central bankindependence and monetary stability was developed by Kydland and Prescott (1977) andextended by Barro and Gordon (1983). According to this model, there is an inflationary bias
inherent to monetary policy due to the time inconsistency problem. If policymakers are able toconvince the public of a certain inflation target, the government has an incentive to "surprise"
the economy with an inflation shock to reduce unemployment. But inflation surprises cannot
arise systematically in equilibrium when people understand the policymaker's incentives andadjust their inflationary expectations in order to eliminate a consistent pattern of surprises. In
this case, the potential for creating ex-post inflation shocks means that, in equilibrium, theaverage rates of inflation will be higher than otherwise. Therefore, the equilibrium rates ofinflation can be lowered by shifts from monetary institutions that allow discretion to ones thatenforce rules. Rogoff (1985) proposed to delegate monetary policy to a "conservative" central
banker whose dislike for inflation relative to unemployment is known to be stronger than
average, which established a theoretical rationale for creating an independent central bank.
A third theoretical argument supporting central bank independence is to avoid the politicalinfluences of political business cycles on monetary policy. According to this argument, thesource of inflation is excessively loose monetary policy because of political influences ofgovernments trying to improve their re-election chances. Governments thus routinely attempt
to time their use of monetary policies to exploit delays from expansionary policies to theirinflationary consequences to secure high growth before elections, with the inflationary effectarising post-election. Central bank independence can limit the inefficient fluctuations ofinflation created by political cycles. In this context, the meaning of "independent" central
banker implies terms of office going beyond that of the government, that is, a central banker
cannot be easily removed by a newly appointed government and replaced by a different
central banker, more sympathetic to the new executive (Alesina, Cohen, Roubini 1997).
A large number of empirical studies construct measures on central bank independence toconnect these different strands of theoretical work and test the impact of central bankindependence on monetary stability (see Eijffinger and de Haan 1996, Berger et al. 2001, Hayoand Hefekre 2002, and Cukierman 2008 for surveys). Authors confirm a negative correlation
between central bank independence and inflation for industrial economies (Alesina andSummers 1993, Grilli et. al. 1991, Cukierman 1992, Cukierman et al. 1992). By contrast,
inflation is not related to legal central bank independence in the group of developing countries(Cukierman et al. 1992). However, when central bank independence is defined by more

3
behaviourally oriented proxies of central bank independence, such as the actual turnover ofcentral bank governors and the political vulnerability of the central bank governor, a negative
correlation between central bank independence and inflation is confirmed also for developing
countries (Cukierman 1992, Cukierman et al. 1992, Cukierman and Webb 1995).
We aim at testing the relationship between central bank independence and monetary stability
in historical perspective. Concretely, we focus on the period of the classical gold standard. On
the eve of the First World War, Europe had achieved a high degree of central bankindependence. Capie et al. (1994) contend that monetary laissez-faire dominated the gold
standard period. The state tended to keep its distance in monetary matters and the central
banks assisted the gold standard. Flandreau et al. (1998) analyse the evolution of central bankindependence in Europe during the gold standard period. Central bank independence wasrepeatedly violated, especially when recurrent fiscal difficulties were experienced. But, after
1896, central bank independence was gradually reconstructed and the protection of central
banks against political pressures to monetize debt was high in the years immediately preceding
the First World War.
According to Flandreau et al. (1998), central bank independence was the endogenous outcomeof negotiations that codified state-banks’ relations when charters were drafted, and theiradjustment over time following actual changes in underlying power relations. Power relations
differed between the core and peripheral Europe. For countries that enjoyed stable goldadherence (Britain, France, Germany, Belgium, the Netherlands, and Scandinavia), substantialbalances in the relationship between the government and the central bank characterized thegold standard period. On the contrary, in central-eastern and southern Europe (Russia, AustriaHungary, Portugal, Greece, Italy and Spain), state-bank relations changed over time anddiffered from those prevailing in core countries. While central-eastern and southern Europe
gradually adopted the protection of central banks against political pressures to monetize debt –with the exception of Portugal– they were unable to commit to gold adherence.
Higher central bank independence did not ensure durable monetary stability for peripheral
Europe as it did for north-western Europe. Case studies on the power relations that codifiedstate-central banks outcome of negotiations on monetary stability might explain why central
bank independence generated monetary stability in core but not in peripheral Europe. Veryfew studies document state-central bank power relations during the classical gold standard
period. Holtfreich (1988) and Bouvier (1988) very briefly discuss the cases of Germany andFrance respectively. To our knowledge, no systematic empirical research exists addressing thisquestion for peripheral Europe.
We focus on the case of Spain. We combine the literature on central bank independence
together with measurements on the degree of strength of political institutions to explain why
central bank independence did not ensure monetary stability in peripheral countries during thegold standard period. The detailed analysis of the political and central bank institutional design
permits the relations between the fiscal and monetary authorities and their changes over time
to be examined. This approach opens the scope from the conceptual framework of central
bank independence to a broader view that considers also the quality of political institutions.

4This approach would be in line with Acemoglu et al. (2008) who suggest that the success ofcentral bank independence depends on political institutions.
The Bank of Spain was granted the national monopoly to issue banknotes in 1874. Spain had abimetallic standard de iure, that is to say, the local currency was convertible into gold or silverat the discretion of the Bank of Spain. Gold adherence was never an explicit target. The Bank
applied an orthodox monetary policy, and the gold standard was maintained de facto until
1891, when the charter was renewed, and the Bank of Spain stopped defending the exchange
rate (Martínez-Ruiz and Nogues-Marco 2014). After 1895, the exchange rate depreciatedsharply, and the depreciation of the peseta reached its maximum level in 1898-1899 whenmoney creation largely financed the Spanish-American War. After 1900, the government
introduced a deflationary policy aimed at stabilizing the exchange rate. The politicalauthorities’ objective was to join the gold standard and an orthodox fiscal policy was designed
to introduce it. Yet the gold standard was never resumed, because the Bank of Spain refused todeflate the economy.
Decisions affecting the exchange rate are explained in this paper, based on the fluctuatingbalance of power between the government and the central bank and determined by thecurrent institutional framework in each year. Thus, section 1 describes monetary stability as theoutcome of negotiations between the government and the central bank, which depended on
the relative power of the two institutions. We then construct two indexes to interpret the
dynamics of state-banks relations. Section 2 elaborates the index of political strength based on
variables related to both political stability and the financial situation. Section 3 calculates acentral bank independence index based on variables related to the terms of chief executive
officers, policy formulation, and limitations on government lending. Section 4 measures theprobability of gold standard adherence as a function of the balance of power between thegovernment and the central bank. The final section provides a conclusion.
Econometric results show that higher central bank independence did not generate monetarystability. Both central bank independence and political strength are significant variables in
explaining exchange rate stability. Central bank independence is negatively correlated with goldadherence, while political strength shows a positive correlation. Results confirm that a highly
independent private central bank avoided the responsibility of defending gold adherence whennegotiating with weak government, even in a stable macroeconomic environment. Our
research suggests that the success of central bank independence in generating monetarystability during the gold standard period depended on sound political institutions.

1. The Political Economy of Monetary Stability
The monetary stability of the gold standard depended on the national issuing regulations.
Spain used two limits to regulate issuing, one defined a minimum reserves and the other amaximum banknotes ceiling.1 The legislation set limits on the issue of notes in the 1874 decree
1

Countries used three types of systems to limit issuing: (1) fiduciary systems, in which the central bank was
permitted to issue a limited amount of currency not backed by gold reserves (Britain, Norway, Finland, Russia andJapan); (2) proportional systems, when gold could not fall below a proportion of banknotes, typically 35 or 40
percent (Belgium, the Netherlands, Switzerland); (3) hybrids of these two forms, which combined both an issuing5that granted the Bank of Spain the monopoly of issuing. These limits were changed several
times during the classical gold standard period, concretely in 1882, 1891, 1898, 1899 and 1902.
The numerous changes in issuing limits are remarkable. It is also striking that the institutionalframework of issuing regulations was not enacted by the government to preserve monetarystability, but instead negotiated between the government and the Bank of Spain in order toachieve private interests. On the one hand, the government aimed at monetizing debt without
increasing the issuing ceiling, that is, by trying to persuade the Bank to reduce the private
earning assets in exchange for increasing the public earning assets. On the other hand, theBank aimed at increasing the issuing ceiling. This would improve profitability by increasing the
public earning assets without reducing the private earning assets. Here we need to interpretcentral bank objectives in a historical perspective. Nowadays, the central bank’s objective is toguarantee monetary stability. Historically, however, central banks were private banks looking
for profit (Goodhart 1988, Flandreau 2008, Blancheton 2016). A priori the bank of Spain was
not interested in monetizing public debt without increasing the issuing ceiling, because theprofitability of the private earning assets was higher than the profitability of its publiccounterpart. However, the bank of Spain would be willing to monetize debt if the issuing ceiling
was increased, because this would report an additional source of revenues. Conversely, thegovernment would want to avoid increasing issuing ceiling because, despite the short-term
cost being lower than financing debt in the market, it would cause the suspension of the gold
standard, currency depreciation and the increase of the risk premium on sovereign debt.
Changes in issuing law were the result of bargaining between the government and the Bank.
Bargaining is a process through which the actors try to reach an agreement. Each actor would
prefer to reach an agreement, but also to reach an agreement as favourable as possible(Muthoo 2000). The bargaining outcome is determined by the sources of each actor's
bargaining power. The threat of non-renewal of the issuing monopoly was the main source of
bargaining power of the government and it put pressure on the central bank to reach an
agreement.2 The government had the legal right to grant the monopoly of issuance to thecentral bank. As a consequence, if the central bank perceived a risk of losing the issuingmonopoly, it would be willing to create money for the government in exchange for maintaining
the issuing privilege. This was indeed the case for the Bank of Spain.
The charter granted to the Bank of Spain in 1874 was intended to be temporary, with a term of
30 years. No one argued against the temporary nature of the charter, that became the main
instrument for exerting control over the Bank of Spain, since it seemed likely that thenegotiation for renewal would be problematic. For example, possible subsequent non-renewal
ceiling and a proportion between gold and banknotes, such as the systems of Germany, Austria-Hungary andSweden (Eichengreen 1996, p. 23). Spain was in the third group of issuing regulation. A detailed description of thelegal limits for banknotes issued by the Bank of Spain, both banknote ceiling and minimum reserves, is available in
Martín-Aceña et al. (2012), Table 8.1.m p.153.
2
Although from a modern perspective the eventual withdrawal of the charter might seem inconceivable because of
the very likely subsequent collapse of the monetary system, this situation was by no means exceptional incontemporary Europe, where issuing banks were in general considered as just another privileged company.
Furthermore, in Spain the concession of privileges in exchange for revenues or credits had a long-lasting tradition
and it is also worth mentioning that the normal length of such concessions was between 20 and 30 years. See
thFlandreau et al. (1998) for dates of charter revisions of the European central banks in the 19 century, and Broz and
Grossman (2004) for the Bank of England case before 1844.

6
was one of the main arguments of shareholders opposed to the acceptance of the charter in
1874.3 The Commercial Code of 1885 provides further proof, which made clear the temporary
character of the charter and the plausible return to the banking structure of multiple provincial
issuing banks 10 years after the Bank of Spain obtained the issuing monopoly: "issuing banks
may issue notes, but admission to the transactions will not be enforced. This freedom to issuebanknotes will be on hold, however, while the privilege currently enjoyed by Bank of Spain
subsists".4
From 1874 to 1898, the Bank forced negotiations to increase the issuing ceiling at the exact
moment when the government asked for debt monetization because the government was
weakened when it was in a hurry to monetize. The actors' degrees of impatience play animportant role in the outcome of bargaining (Muthoo, 2000); the greater the degree of
impatience of the government, the lower its bargaining power. Figure 1 shows the relationshipbetween public earning assets and banknote ceiling. The negotiations were held when theamount of public earning assets had reached the maximum legal issuing, that is, in 1882, 1891
and 1898.
FIGURE 1. NOTES AND PUBLIC DEBT HELD IN THE BANK OF SPAIN PORTFOLIO (million ptas)
2,500

Law
1899

Law
1898

2,000
1,500

banknotes ceilingbanknotes in circulation

1912

1910

1908

1906

1904

1902

1900

1898

1896

1894

1892

1886

1884

1882

1878

1874

0

1876

500

1880

Law
1882

1890

Law
1891

1888

1,000

Law
1902

public earning assets

Source: Authors’ calculations. Banknotes in circulation and public earning assets in Minutes of the Shareholders’
General Meetings, 1874-1914. Banknote ceiling in Martín-Aceña et al. (2012), Table 8.1.m p.153.

The issuing ceiling increased as a result of negotiations in 1882 and 1891, suggesting a gradualgain in the Bank's bargaining power (Figure 1 – Laws 1882 and 1891). In 1882, the maximum
amount of banknotes increased from 500 to 750 million ptas. In 1891, the issue limit was set at
1,500 million ptas. The Bank used the financial needs of the government to renegotiate thecharter renewal before the expiry date, which further reduced the government´s bargaining
power as the threat to not renew the charter was the main source of bargaining power of thegovernment. In 1891, thirteen years before the first charter had elapsed, the monopoly of
issuance was renewed for another 30 years, until the end of 1921. As a result of the bargaining
agreement attached to the law that regulated the renewal, the government obtained a newlong-term loan of 125 million ptas from the Bank to be repaid in 1921. The Bank of Spain inturn achieved the renewal of the charter. The "exchange of jointly held interests" between the
3

Bank of Spain, Archives, Proceedings of the Annual General Meeting of the Shareholders, 19, 23, 24 and 25
February 1874 (Secretary Box 708)
4
Commercial Code 1885. Paragraph 179. See also Salvador Armédariz (2000), p. 63

7Bank and the Government was the expression used by the Bank during negotiations to justify
rescuing the Treasury in exchange for increasing issuance limits.5
The issuing limit reached its maximum level in 1898, when the financial consequences of thecolonial wars in Cuba generated an important rupture in the evolution of Spanish publicfinances. The 1898 decree authorised the Bank of Spain to increase the issue of notes to avalue of 2,500 million ptas (Figure 1- Law 1898). The wars produced a sharp increase in
spending impossible to finance by ordinary revenue. The main source to meet such
extraordinary expenditure was debt, especially short-term debt placed in the Bank of Spain andhence monetized. Negotiations were commenced to define the conditions for the monetizationof debt. The Bank's board of governors proposed absolute freedom to issue notes without aceiling, while establishing reserves only in silver. Removing the issuing ceiling was, according to
the board of governors, the "golden dream" for the Bank of Spain. 6 The final bargaining
agreement was the increase of the issuing limit from 1,500 to 2,500 million ptas.7 The Finance
Minister announced in Parliament that allowing the increase in issuing was a temporary
measure designed to obtain revenue during the emergency of wartime. 8 The consequent
growth of the money supply, coupled with uncertainty about the wars, brought about the
sharply depreciation of the peseta.
Bordo and Kydland (1995) interpreted gold standard rule as a contingent rule. Only in case ofwell-understood emergencies, such as a war, temporary departures from the rule would bepermitted on the assumption that convertibility of the national currency into gold would
restore once the emergency passed. Britain, France and the United States all suspended specie
convertibility during wartime. They also restored parity once the emergency passed. The rule
was contingent in the sense that agents understood that the suspension would last only forthe duration of the emergency plus some period of adjustment and that afterwards thegovernment would adopt the deflationary policies necessary to resume payments at theoriginal parity between the currency and gold.
In the case of Spain, the government adopted an extensive debt conversion reform to stabilize
the exchange rate after the Cuban War of Independence. This reform reduced short-term debt
hold on the bank of Spain portfolio near fivefold, from a maximum of 1,811 million ptas in 1898
to a minimum of 383 million in 1908, so that in this year it reached a level comparable to themid-1880s (see Figure 1). However, the debt conversion reform did not lead to an orthodox
monetary policy. Fiscal discipline substantially reduced the public debt held in the Bank of
Spain’s portfolio, but banknotes in circulation were not reduced (see Figure 1), as monetarydeflation was partially sterilized. Public earning assets were not redeemed by reducing
banknotes in circulation, but by increasing silver reserves and private earning assets. Between
1898 and 1908 silver reserves multiplied fourfold (from 197 to 810 million ptas) and private
earning assets multiplied fivefold (from a minimum of 128 to 697 million ptas).9 The exchange

5Bank of Spain, Archives, Minutes of the Board of Governors Meetings, 30 April 1889
Bank of Spain, Archives, Minutes of the Board of Governors Meetings, 22 April 1898
7
Bank of Spain Proceedings of the Annual General Meeting of the Shareholders, 1898, pp. 28-29. Decree of 9 August
1898, authorized on 17 May
8Sarda (1948), pp. 213-214
9
Bank of Spain Proceedings of the Annual General Meeting of the Shareholders, 1898-190868rate did not converge with gold parity because sterilization prevented deflation, despite fiscal
discipline.
Deflation was not achieved because the legal issuing limits were not reduced sufficiently toforce the Bank to withdraw banknotes from circulation (Figure 1- Laws 1899 and 1902). As wehave seen, legal issuing limits were not defined by the government but negotiated between thegovernment and the Bank. The final output depended on the relative bargaining power. The
Law of 1899 only reduced the ceiling on issuing from 2,500 to 2,000 million ptas. The Finance
Ministry agreed with the Bank of Spain to reduce the interest rate paid by the government loan
in exchange for maintaining a high issuing ceiling. This interest rate was at an annual rate of
2.5%, far below the discount rate which was 4% at that moment. The logic of this agreement
was that a high issuing ceiling would report a profit to the Bank to compensate for the interest
reduction on government lending.10 Again, in the negotiation of 1902 the Bank was able tomaintain the limit on issuing without any decrease, in exchange for reducing once more theinterest rate on government lending to 2%.11 Monetary stability was not achieved as the legal
issuing ceiling did not decrease enough to reduce the exchange rate to a level compatible withthe adherence to gold. As we will see in section 4, the Bank of Spain blocked gold adherence
from that moment on, despite government attempts in this respect.
To sum up, the stability of the exchange rate depended on the issuing regulations. The
numerous changes of issuing limits are remarkable for the case of Spain. As we have seen inthis section, issuing regulations were the result of the bargaining power between the central
authority and the monetary authority. The following sections measure the evolution of
government power and central bank independence in order to quantify the relative bargaining
power of the two institutions throughout the gold standard period.

2. The Index of Government Influence
Our general claim is that monetary stability, understood as exchange rate stability, wasdetermined by the interaction of two institutions, the government and the Bank of Spain,
whose bargaining positions changed over time. To capture these changes, we construct two
indices to measure the relative strength of each actor over time: an independence index for
the Bank of Spain and a power index for the government. The government power index iscomposed of criteria regarding two different dimensions. On the one hand, a politicaldimension that attempts to capture the degree of stability of the political system. On the other
hand, a financial or economic dimension intended to capture how much room for manoeuvre
the government enjoyed in financial matters. The variables incorporated are summarised in
the Appendix (table A1).
Political stability is key to determining the capacity of a given government to carry out a soundmacroeconomic policy, as possible weakness of the executive would undermine the credibility

10Bank of Spain, Archives, Minutes of the Board of Governors Meetings, extraordinary session 1 Aug 1899. The
bargaining agreement contained a clause which stated that an eventual increase of the issuing limit to 2,500 million
ptas would not require further compensation from the Bank to the Treasury (Martínez Mendez 2005, chapter 10)
11
See also Martínez-Ruiz and Nogues-Marco (2014), p. 26

9of any agreement, thereby limiting the possibility of executing political projects.12 In our case,that would mean that a weak and unstable government would find it more difficult to enforce
on the Bank of Spain any decision on monetary policy that the central bank found harmful to
its interests.13 A broad range of indices of political stability is to be found in literature on
economics and political science. This includes a wide variety of indicators, ranging from thepermanence of the executive (term of office), to the degree of political violence (number ofcoup d'état, strikes or political revolts), or to institutional characteristics (ways of selecting theexecutive and constraints on executive decision-making or the extent of political participation).
We have considered two proxies that are intended to capture the turnover rate of thegovernment (President of the Council of Ministers, too 1, and the Minister of Finance, too 2),
firstly because as Grilli et al. (1991) have demonstrated, the durability of governments is themost significant variable when explaining political responses to macroeconomic turbulence.
Furthermore, as we explain below, various features of the true functioning of the Spanish
political system justify this choice.
The political regime in Spain from 1874-1923 is known as the Restoration, since it was therestoration of the Bourbon dynasty, after 6 years of political instability known as the "sexenio
revolucionario" (six-year revolution), which initiated this long period of constitutionalmonarchy.14 The 1876 constitution established that sovereignty was shared by the Parliament
and the King. The power of the Crown was reinforced as the King bore the authority to appoint
the President of the Council of Ministers and even the Ministers, and shared legislative powerwith Parliament, maintaining the right of absolute veto over laws passed by Parliament.
Furthermore, the monarch had the power to summon, suspend or dissolve Parliament. The
aim of such laws was to enhance stability, since in the foregoing 50 years Spain had
experienced more than 25 major political disruptions (civil wars, coup d'états or drasticchanges to the regime). At the outset this objective was fulfilled, although over time thecharacteristics intended to ensure stability would in fact become part of the problem, since theoperation of the system depended crucially on the personality of a limited number of actors,
as will be shown below.
The constitution did not specify the franchise for electing Congress, although the electoral lawof 1878 established restricted suffrage, restricted to major taxpayers, which lasted until 1890,
when universal male suffrage was reintroduced. This could have constituted a major change inparticipation. But the Restoration was far from a democratic system as understood today, andeven far from a bourgeois democracy in which participation was reserved for privileged groups.
The political system of the Restoration was based on the existence of two major parties, theConservatives and the Liberals, who agreed on a regular alternation of power. This "turn andturn about" between the two large parties was also intended to ensure stability. The shift in
power was guaranteed because the electoral system overturned the rules of the parliamentary
system in which the majority force following an election. Thus, when the ruling party suffereda process of political attrition and/or lost the confidence of Parliament, the monarch
12

There exists extensive literature on the relationship between politics and economic policy; among others, see
Persson and Tabellini (1990), Grilli et al. (1991), Persson (2002), Aemoglu et al. (2003) and Besley and Case (2003).
13
As Acemoglu et al. (2003) demonstrate, inadequate macroeconomic policy is often only a symptom of
institutional problems that allow powerful interest groups to "extract" rents from the rest of society.
14
An excellent characterization of the Restoration political system is to be found in Jacobson, S. and Moreno-Luzón,
J. (2000)10
summoned the head of the opposition party to form a government. The new government thencalled elections in order to build a sufficient parliamentary majority to exercise power in astable manner. Alternation in government was also made possible by the manipulation ofelections (Jacobson and Moreno-Luzón, 2000, p.98). The party organising the elections did nothesitate to buy votes, falsify records and pressurize the electorate, using the influence andeconomic power of certain individuals in society (caciques). The adulteration of the vote wasachieved by the more favourable treatment of rural compared to urban districts and,especially, by widespread electoral fraud.
Furthermore, the two main parties were not modern mass parties, in today’s terms, with
headquarters, groups, and affiliates. They were parties of “notables", that is to say they were
the result of the meeting of several political leaders with their respective clienteles, their press
and local support. Thus, each of these politicians led a faction. The leader's task was to holdtogether the different factions of the party, and spread the benefits of balanced power
between them. The centrifugal tendency of factions was constant: their leaders supported thegovernment in exchange for compensations, for example the distribution of government
offices. 15 If satisfactory agreements were not reached, the factions could display theirdiscontent in Parliament. When a party lost internal cohesion while in government, the King
would withdraw his confidence and call for the opposition to form a new government andorganise new elections, through what is known as "a decree of dissolution". That means thatgovernments could fall after losing the confidence of the King, the Houses of Parliament, or
both.
Therefore, the consideration of proxies (too1 and too2) which reflect the turnover rate
(President of the Council of Ministers) and the Minister of Finance respectively, allow us toaccount for governmental stability in a period without major institutional changes where,
however, the "human factor" was of paramount importance. From 1874 to 1913 the President
changed 33 times, providing an average tenure of barely 15 months in office. Someconsiderations are necessary to understand the true meaning of these numbers. On the one
hand, cabinet changes under the same presidency were very common, since government
composition was always the result of fragile compromises among the different factions of aparty. This made the government even more unstable than the computed numbers show. For
example, in the same period there were 49 Ministers of Finance, meaning that the head of
economic policy lasted on average 10 months in office. On the other hand, of course, thePresidency of the Council of Ministers almost always went to the leader of one of the two main
parties, and thus the number of persons occupying the Presidency was much lower. There
were only 17 presidents, and some of them occupied the position for many years even if in
different periods. For example, from 1874 to 1902, the presidency was occupied by Canovas or
Sagasta for almost 25 years, and thus in that period only five other persons were designatedpresident and only for very brief mandates that sometimes lasted only a matter of months.
This depicts a more stable government than the numbers show.

15

Or allocation of government spending for certain provinces or territories. See for example Curto-Grau et al.
(2012)

11
The last consideration refers to the difference in time. The system seemed to work as expectedduring the nineteenth century, but by the end of the century some weaknesses of the systemwere apparent. As Figure 2 shows, instability rose as years went by.
FIGURE 2a. TERM OF OFFICE FOR THE PRESIDENT OF THE COUNCIL (MONTHS)

Source: Urquijo Goitia (2001)

FIGURE 2b. TERM OF OFFICE FOR THE MINISTER OF FINANCE (MONTHS)

Source: Urquijo Goitia (2001)

12This was due to a variety of causes. Firstly, from the above description of the system it isevident that the party leader had to be a figure with sufficient charisma to control the party’s
factions. During the last quarter of the nineteenth century, Canovas and Sagasta were theundisputed leaders, but after their deaths the internal divisions in their respective parties
raged.16 Other factors also contributed to the rising instability of the Restoration system. Given
the reigning electoral malpractices, a moderator was needed to interpret the feelings of public
opinion and to avoid the tendency of all parties to remain in power once having gained it. Thiswas precisely the role attributed to the King who decided when to appoint or dismiss the
President of the Council or to dissolve Parliament. The character of the monarch was therefore
an important feature of the system. Alfonso XIII assumed the crown in 1902. He was, unlike his
predecessors, a king with political ambitions, ready to reign and rule (Moreno Luzón, 2003). He
therefore intervened more directly in politics, assuming his constitutional role as the chief ofthe executive at the expense of the constitutional principle of ministerial responsibility.
Moreover, the emergence of new parties and the weakening of the historical parties gave
greater prominence to Parliament, making governments weaker.
When the indicator of the turnover rate of presidents is calculated for the two different
periods, before and after 1902, striking differences arise. The number of presidencies from
1874 to 1902 was 17, with an average of over 20 months in office. Very long tenures weresometimes registered. Canovas was President for almost 40 months between 1875 and 1879
and Sagasta lasted 59 months, nearly 5 years between 1885 and 1890, in what is known as the"long Parliament". By contrast, between 1900 and 1913 there were 19 changes in the
Presidency, with an average tenure of barely 10 months. Table 1 shows these differences bydecades.
TABLE 1. AVERAGE TERM OF OFFICE FOR THE PRESIDENT OF THE COUNCIL AND THE FINANCEMINISTER BY DECADES (IN MONTHS)

1874-1880
1881-1890
1891-1900
1901-1910
1911-1913

President Minister
15.0
15.1
26.2
15.6
20.6
15.2
8.8
5.5
15.1
11.3

Source: Figure 2

The case of the Ministers of Finance clearly reflects the growth of political instability: until
1902 the average tenure of ministers in office was about 15 months. There were even two
who lasted more than 30 months. During the first years of the reign of Alfonso XIII continuity
declined to the point of barely reaching six months (on average, from May 1902 to December
1913). In one single year (1902) there were five ministerial changes. This high turnover had farreaching effects on governmental action, as many governments eluded important reforms inorder to prevent rejection by Parliament that would mean the end of the minister who had
defended the proposal and sometimes even of the whole government (Martorell Linares,
2012).
16

Canovas died on 8 August 1897, while Sagasta passed away on 5 January 1903. King Alfonso XIII took power on 17
May 1902.

13
Concerning the economic dimension, three proxies are included in the index, all of them
related to the state’s fiscal strength. A deficit criterion (Def), defined in the conventional way
as fiscal balance/GDP, measures the net borrowing of the state each year. The bigger the
deficit, the less able is the government to impose conditions on other economic agents. The
last two criteria reflect government choices for the financing of such deficits. Firstly, we
consider the significance of financing by the central bank (CB financing). This variable reflects
the percentage of total state debt present each year in the Bank of Spain´s balances andtherefore monetized. In this case the bigger the share of debt placed in the Bank of Spain, themore dependent was the government on its central banker. The last criterion (Extdebt) is
intended to capture the access of international markets to Spanish sovereign debt andconsequently to reflect government leeway when deciding how to finance their deficits. The
proxy is based on the significance of external debt in the total volume of public debt (thevariables are plotted in Table A1 in the Appendix). The greater the external debt, which means
the easier the access to foreign markets, the more freedom the government had to choose theoptimal portfolio for funding public debt, minimizing the cost of financing by going to the mostliquid foreign markets that offered better conditions.17 In effect, the observation of the yields
that the bank obtained from its portfolio of public securities reflects that these were triggered
when a suspension of the external debt or an unfavourable political situation closed the accessto international markets, as was the case between 1874 and 1879.
The final step in the construction of our influence index is to aggregate the different elements
in a single indicator that ranks from a complete absence power (0) to total power (1). We haveproceeded in two steps: firstly, two different variables for political stability and financial
strength were calculated, as an unweighted average of the relevant proxies in each case.
Secondly, these two variables were aggregated once more, as an unweighted average. The
result is shown in Figure 3.
FIGURE 3. GOVERNMENT INFLUENCE INDEX

17

For possible explanations of the borrowing in foreign financial centres see Flandreau and Sussman (2004)

14
As can be seen in Figure 3, after 20 years of relatively unchanged government strength, thereactivation of separatist conflict in Cuba brought about a weakening of executive power,
mainly driven by the worsening of the state’s financial position, caused by the increase inmilitary spending. From 1901 on, the government was able to reverse the state of its finances
and the financial strength variable shows a progressive improvement. The index ofgovernment influence, however, does not record a recovery until five years later, due to thepolitical instability that followed the war. Thus, the considerable effort made to consolidate
public finances during the period 1900-1902 was undermined by the weakness of a politicalsystem unable to adapt to the new reality of the country.

3. Central Bank Independence Index
As for the independence index, we have taken advantage of a wide range of empirical studies
which attempt to prove the positive relationship between central bank independence (CBI)and monetary stability.18 Several measures of CBI have been developed and discussed sincethe 1980s, but the most widespread are the Grilli-Masciandro-Tabellini index (1991) and the
Cukierman index (1992).19 We build on this empirical literature, beginning specifically from thelegal independence indices constructed by Cukierman (1992) and Cukierman, Webb and
Neyapti (1992). Our measure therefore identifies a set of relevant features of independence
related to three basic aspects of the bank´s functioning: those related to the chief executive
officer (CEO) of the bank, those concerning the mandate, the objectives and the autonomy of
the bank in monetary policy formulation (MONPOL), and, finally, those linked to the ability ofthe bank to shape financial relations with the government. As for the first category, thegeneral logic is that the greater the independence of the central bank, the greater will be theindependence of the CEO. Furthermore, the more room the bank has to decide on interest
rates, reserve movements or the expansion of money and credit, the more independence will
there be for monetary policy. Finally, in the case of limits or regulations on the ability of thegovernment to borrow from the bank, in a broad sense, then the more closely regulated or
restricted governmental lending, the more independent is the bank from pressures to divert
resources to the state, and thus the greater is its capacity to pursue its own objectives.
We capture the legal regulation of each dimension on the condition that it is contained in the
different laws, decrees and/or agreements. 20 Table A2 of the Appendix summarizes thefeatures included in the Legal Independence Index (LIWA), the respective codification and abrief description of each variable included in the index. The first group (called CEO)corresponds to the variables that affect the chief executive officer/CEO of the bank, thegovernor in our case. Two legal dimensions have been taken into account: who bears the legal
authority to appoint (App1) and who can dismiss the governor and why this can happen (Diss1).
18

If nowadays monetary stability is identified almost uniquely with price stability, before the First World War
monetary stability meant exchange rate stability.
19
A very large number of empirical studies has constructed indexes on central bank independence to measure therelationship between central bank independence and monetary stability. Eijffinger and de Haan 1996, Berger et al.
2001, Hayo and Hefekre 2002, and Cukierman 2008 summarize main contributions. The advantage of using
standardized indexes on central bank independence is that they facilitate comparisons across countries and periods.
20
We have not included all the characteristics considered by Cukierman et al (1992), for example the legal term ofoffice of the governor, if the governor held another office, the role of the bank in the budgetary process or otherpotential borrowers from the bank, because none of these appeared in the charter.

15
The more authority the government has in appointing or dismissing the governor, the lessindependent will be the central bank. In the policy formulation dimension (MONPOL), we try
to capture the Bank of Spain's ability to formulate monetary policy. This is captured throughtwo proxies, who formulates policy (Formpol) and who resolves conflicts (Conf). The Formpol
criterion measures the degree of responsibility in the formulation of monetary policy
attributed to the central bank. The Conf criterion tries to capture the ability of the Bank toresist pressure from the government to adopt a policy measure, by determining who has thepower to solve an eventual conflict. The greater was its capacity to oppose government orders
and/or suggestions, the more independent was the bank. With regard to the limitations of thecapacity of the government, or more generally the public sector, to borrow from the Bank of
Spain, 5 proxies have been included to capture aspects such as limitations on advances (lla) or
securitized lending (lls), or regulation of the conditions of lending, in general (ldec), or more
specifically maturity (lmat) and interest rates (lint). In this case, in a broad sense, the stronger
the restriction, the more independent was the bank from pressures to divert resources to thestate. Each variable has received a coding for each year from 1874 to 1914.
The final step in the construction of our Legal Independence Index is to aggregate the different
elements in a single indicator that ranks from zero independence (0) to total independence (1).
We have considered the weights proposed by Cukierman et al. (1992) and, like them, we haverescaled the weights according to the data availability for our index (see Table A4 of the
Appendix for the weights used for LIWA). The aggregation was performed in two stages. Firstly,
two variables were obtained, CEO and MONPOL, from the aggregation of corresponding
features, mentioned above. Secondly, we averaged two variables concerning lending to the
public sector, conditions regarding loan maturity and interest rates, in a single variable. The
other 3 variables concerning limitations imposed on the bank to lend to the public sector are
treated separately. The six variables were then aggregated once more to obtain the final legal
index (LIWA).21
Secondly, we extended the legal independence index with another aspect considered in theliterature. Thus, Grilli, Masciandro and Tabellini (1991) pointed to the importance of the rules
for appointing and dismissing not only the Bank of Spain’s CEO, but also the rest of the Bank’sboard.22 In the period analysed the Bank of Spain’s boards were elected by the shareholders
and the government had no representation, except for the governors. But the high turnoverrate of the governors had important consequences for the effective management of the Bankof Spain. The brevity of terms in the central bank prevented the governors from acquiring thenecessary familiarity with the organization and customs of the Bank of Spain, or even fromdeveloping a sound network of internal bonds and loyalties that could ensure support in caseof disagreements.23 This means that the governors had great difficulty in playing a useful rolein the effective management of the institution and in monetary policy, or that they could only
21

Following Dincer and Eicheengren (2014), we calculate the correlation between weighted and unweighted
indexes. The four measures of Independence, LIWA, LIUA, ELIWA and ELIUA are strongly correlated, showing that
results are not influenced by the weights chosen (see Table A6 of the Appendix).
22
Also in Eijfinger and Schaling (1993) and Jacome and Vazquez (2008)
23
Many of the chosen governors had some proficiency in financial topics, although this was not always the case. To
our knowledge, the range of expertise was very broad, from relatively skilled people in the relevant areas to those
without any experience at all. But the capacity to really manage the Bank was limited, even when the governor was
an expert.

16
do so at the cost of a high level of conflict. These circumstances awarded a very important roleto the figure of the Deputy Governors (DGs), who in fact assumed the function of managing
the normal activity of the Bank. 24 From the study of the Bank's internal decision-making
process, it is evident that not only the internal administration, but also the main operational
decisions were essentially influenced by the personality and ideas of the DGs. For thesereasons, two new proxies have been included (App2, Diss2) to account for the same
dimensions as in the case of governor. The new criteria have been aggregated as part of CEO.
So a new index, the Extended Legal Independence Index has been obtained (see Table A5 of
the Appendix for the weights used for ELIWA).
We then constructed a broader measure of independence (INDEPWA) that incorporates not
only this detailed consideration of the legal aspects, but also the actual results of the more orless informal arrangements, the customs of the bank or the personalities of the individuals
responsible. The legal status of the central bank is the obvious starting point, not only because
it is the most straightforward way to proceed, but also because it allows us to approximate theintentions of the government with respect to the issues analysed. However, it requires some
important qualifications based on the detailed analyses of the actual functioning of the banksince, on the one hand, not every element is included in the legal texts and, on the other, theactual application of norms is in many cases more important than the initial intention of thelegislator.
To the legal criteria, therefore, some proxies for actual independence have been added. Actual
independence may often deviate, quite substantially, from legal independence. Suchdeviations depends on the degree of enforcement of the law (Cukierman 2008, p. 723). A
broadly used indicator of de facto independence is the real term of office of the governors(too3), on the understanding that a governor who remains in office longer than thegovernment is more able to resist the pressures of the executive branch and/or to implement
longer-term policies not necessarily shared by the incumbent governments.25 This indicator
has also been included for the deputy governors (too4). These variables have been added toCEO. On the other hand, in order to account for the actual compliance with the limitations on
advances and securitized lending, we have calculated the existing amounts of advances andpublic debt in the Bank's portfolio and have compared them with the legal limits. This is an
important issue since the government’s financial needs were sometimes solved by forcing thebank of Spain to exceed the limits provided by law, which would indicate a greater
dependence of the central bank than the legal texts seem to indicate. Two criteria have been
included clla and clls, a code of 1 being attributed to those years when the limits wereobserved, a code of 0 when they were not (see Table A7 of the Appendix).
We therefore attempt in all these cases to include not only the legal status of the central bank,
but also to account for practice in reality. This decision is crucial for our purposes since we try
to capture the real room for manoeuvre of the Bank of Spain. In the literature these aspects
are treated separately, so that it is usual to find two different measures: a legal independence
index and a de facto independence index. We have chosen to include both types of proxies,
24

Galvarriato (1932) and Banco de España (2009).
On the contrary, it could be assumed that a governor lasting longer in charge must have been accommodating
government demands. Given the political situation in Spain, as explained above, this possibility is highly unlikely.
25

17
the legal and the de facto or so-called behaviourally oriented ones in the same index, in orderto obtain an operational measure. Table A8 in the Appendix shows the aggregation steps andthe weights attributed in this case (INDEPWA index).26
Once all these aspects are taken into account the degree of independence of the Bank of Spain
is far from low. 27 In fact, the Bank of Spain enjoyed medium and increasing degrees of
independence during the period we analyse. It is also worth mentioning that, as evident from
Figure 4 where the two obtained indexes are shown together, the independence index
experimented an increase around 1900. This change is related to the reform implemented by
the Ministry of Finance – Raimundo Fernández-Villaverde, which affected the regulation of thefinancial relationship between the government and the central bank. The clarification of theframework around 1900 indeed resulted in an increase in the central bank's independence
since, consistently with the ultimate goal of the fiscal reform to pursue exchange rate stability,changes hindered government access to central bank financing.
FIGURE 4. CENTRAL BANK INDEPENDENCE INDEX AND GOVERNMENT INFLUENCE INDEX (18741914)
0.9

0.8

0.7

0.6

0.5

0.4

0.2

1874
1875
1876
1877
1878
1879
1880
1881
1882
1883
1884
1885
1886
1887
1888
1889
1890
1891
1892
1893
1894
1895
1896
1897
1898
1899
1900
1901
1902
1903
1904
1905
1906
1907
1908
1909
1910
1911
1912
1913

0.3

INDEPWA

26

GII

Results are not influenced by the chosen weights (see Table A8 of the Appendix)
Of course this is always a relative measure and cannot be compared with other central banks since, to ourknowledge, no similar index has been constructed for other countries27

18

4. Bargaining Power and Exchange Rate Stability
The gold standard was a monetary system of fixed exchange rates in which currencies were
pegged to gold. The adherence to gold means that the exchange rate fluctuated within theband defined by the “gold-points”, which is the ratio of official gold prices in two centres
plus/minus the cost of shipping gold between them (Officer 1996).
Figure 5 measures gold-points between Madrid and London from 1874 to 1913. The exchange
rate fluctuated within the gold-points from 1874 to 1891. During this period the exchange rate
returned soon to parity with gold when it broke the lower or upper gold-point. However, thedynamic of the exchange rate changed severely in 1891. We observe a structural break in theexchange rate level in the summer of 1891. From that moment to 1913 exchange rates floatedwithout adherence to gold being restored.28
FIGURE 5. MONTHLY EXCHANGE RATE 1874-1913, PTAS/£ (% OFFICIAL PARITY)
200
180

Exchange rate
Upper Gold Point
Lower Gold Point

160
140
120

80

Jan 1874
Apr 1875
Jul 1876
Oct 1877
Jan 1879
Apr 1880
Jul 1881
Oct 1882
Jan 1884
Apr 1885
Jul 1886
Oct 1887
Jan 1889
Apr 1890
Jul 1891
Oct 1892
Jan 1894
Apr 1895
Jul 1896
Oct 1897
Jan 1899
Apr 1900
Jul 1901
Oct 1902
Jan 1904
Apr 1905
Jul 1906
Oct 1907
Jan 1909
Apr 1910
Jul 1911
Oct 1912

100

Source: Authors' calculations. Exchange rate: Boletín de cotización oficial del Colegio de agentes de cambio de la
Bolsa de Madrid 1874-1913, Biblioteca de la Bolsa de Madrid. From 1874 to Dec 1887 the exchange rate in Madridon London was quoted at 3 months. We have converted the 3-month exchange rate to the spot exchange rate (seeFlandreau et. al. 2009; to calculate the spot exchange rate we have used London market interest rates collectedfrom The Economist). Official gold parity Spain-England=25.20 ptas/£. Shipping costs extracted from Actas de laJunta Consultiva de la Moneda, 1876-1888. Archivo del Ministerio de Hacienda, Book 22859, pp. 273-278,29
08/08/1877.

We focus on the power relations between the state and the central bank that codified
monetary stability. The outcome of negotiations has been described in section 1. Here we aim
28

A multiple breakpoint test identifies three break dates: 1891M08, 1897M08 and 1906M02 (trimming 0.15,
significance level 0.01, maximum breaks = 5). Test statistics employ HAC covariances (Prewhitening with lags=1,
Quadratic-Spectral kernel, Andrews bandwidth). Robust results for breaks estimated with Bai-Perron tests of L+1 vs.
L globally determined breaks, Bai-Perron test of 1 to M globally determined breaks, and compares information
criteria for 0 to M globally determined breaks (Schwarz criterion and LWZ criterion). Bai and Perron (1998, 2003)
29
Estimated gold cost is 1.78% (shipping cost from Madrid to London, via Santander), similar to the gold cost
reported by Esteves, Reis and Ferramosca (2009) for the case of Lisbon-London (1.5%)

19
at measuring monetary stability as the result of these power relations. For that purpose,exchange rate stability is modeled as a function of the bargaining power between thegovernment and the central bank:
Prob (exchange rate year i=GOLD) = f (GII year i, INDEPWA year i, CHARTER year i)(1)which states that the probability of gold adherence is a function of the government influenceindex (GII), the bank independence index (INDEPWA) and the renewal of the monopoly issuing(CHARTER).
This model is estimated as a probit in which the dependent variable indicates whether there isgold adherence (that is, taking the value of 1 for the years 1874-1891, and zero otherwise- see
Figure 5). GII is the government influence index explained in section 2. It is an index delimited
between 0 (minimum influence) and 1 (maximum influence). INDEPWA is the central bankindependence index measured in section 3. It is also normalized between 0 (minimum
independence) and 1 (maximum independence). CHARTER is a proxy that aims at measuring
the capacity of the government to put pressure on the bank to reach an agreement onmonetary stability. As we have seen in section 1, the government’s main instrument ofleverage was provided by its capacity of not renewing the national monopoly on paper
currency. This variable has been included to measure the impact of this threat. It is defined as
the number of years remaining for the charter to be renewed. 30
Figure 6 shows correlations between gold adherence and the explanatory variables. Signs are
as expected. The probability of gold adherence increased with respect to the government
influence index, and decreased with respect to the bank independence index and the years
remaining to renew the issuing monopoly. On the one hand, the objective function of thegovernment was to minimize the total cost of debt, subject to the maintenance of an
acceptable level of risk in the long run. The stronger the government, the higher was theprobability of maintaining the gold standard regime that minimized the cost of external debt
by reducing the risk premium. On the other hand, the objective function of the bank was tomaximize profit. The more independent the central bank, the higher was its bargaining power
to expand the issuing ceiling that would increase profitability and, therefore, the lower was theprobability of adherence to gold. Profit maximization was, however, limited by the threat oflosing the charter. The more credible the possibility of losing the charter, the less probable was
the bank’s suspending its adherence to gold. The credibility of the threat of losing the charter
was related to the number of years left for its renewal. The longer period left to renew thecharter, the less effective was the threat regarding its non-renewal (Flandreau et al. 1998, p.
132).

30

We consider the de facto year of renewal. As explained in section 1, the Bank of Spain was granted the issuingmonopoly in 1874 for a period of 30 years. However, the renewal was granted in 1891, 13 years earlier.

20

1
.6
.4

PROBABILITY GOLD

.2

.4

PROBABILITY GOLD

.6
.4

0

0

.2

.2
0

PROBABILITY GOLD

.6

.8

.8

.8

1

FIGURE 6. PROBABILITY OF ADHERENCE TO GOLD WITH RESPECT TO INDEPENDENT VARIABLES

.3

.4

.5

GII

.6

.7

.8

.35

.4

.45
INDEPWA

.5

.55

0

10

CHARTER

20

Table 2 presents the average marginal effects and the average marginal elasticities from theprobit regression. The average marginal effects indicate the change in the probability of goldadherence for an infinitesimal change in the explanatory variable. The average marginal
elasticities indicate the percentage of change in the probability of adherence to gold for a one
per cent change in the explanatory variable. The Pearson chi2 test indicates that we accept the
goodness of fit, and the percentage of correctly classified observations indicates that 92.5% ofprobabilities are correctly predicted (using the 0.5 predicted threshold). The Wald Test accepts
the joint significance of coefficients; and the z-ratio accepts the individual significance ofcoefficients. All the coefficients are statistically significant and their signs are as expected.
TABLE 2. DETERMINANTS OF ADHERENCE TO GOLD IN SPAIN: MARGINAL EFFECTS ANDMARGINAL ELASTICITIES FROM PROBIT REGRESION, 1874-1913
Independent Variable
GII
INDEPWACHARTER

Coefficient
9.633 (3.29) ***-8.051 (3.44) **-0.148 (0.05) ***Marginal effects
0.905 (0.21) ***-0.753 (0.26) ***-0.014 (0.01) ***Marginal elasticity
5.914 (2.96) **-5.542 (3.43) *-4.117 (2.26) *Notes: Correctly classified: 92.05%. AIC: 20.23. BIC: 25.29. Goodness-of-fit test: Pearson chi2 (37) = 16.20(Prob>chi2=0.9988). The number of observations is 40. Robust standard errors are in parenthesis. *** Significant at
the 99 percent level. ** Significant at the 95 percent level. * Significant at the 90 percent level

The marginal effects and marginal elasticities for GII and INDEPWA are nearly equal inmagnitude and of the opposite sign. Gold adherence was the result of the bargaining between
the government and the central bank. Both government influence and central bankindependence are relevant to explain the commitment to gold, government power beingslightly more influential. An increase in bank independence of 1% decreased the probability ofgold adherence by 5.5%. Symmetrically, an increment of government influence of 1%
increased the probability of joining the gold standard by 5.9%.
However, the probit regression is a nonlinear model. The marginal elasticities depend on thevalues taken for the explanatory variables. Table 2 reports the average marginal elasticity, thatis to say the average of the marginal elasticities for each observation. Still, averages canobscure differences in elasticities across cases. To capture the dynamics of the interaction
between the government and the bank, we need to calculate the marginal elasticities for thedifferent levels of government influence and bank independence (Williams 2012). Table 330

21
calculates the marginal elasticities from the probit regression for low, medium and high valuesof the independent variables (GII and INDEPWA). As the GII and INDEPWA indices are series
normalized between 0 and 1, we consider 0.25 as low, 0.50 as medium and 0.75 as high.
TABLE 3. MARGINAL ELASTICITIES FROM PROBIT REGRESSION FOR LOW, MEDIUM AND HIGH
VALUES OF THE INDEPENDENT VARIABLES

low
DEGREE OF
GOVERNMENTINFLUENCE

mediumhigh

DEGREE OF BANK INDEPENDENCE
low
mediumhigh
INDEPWA- 4.298*
INDEPWA -15.854
INDEPWA-35.424
GII 5.159**
GII 9.515*
GII 14.173*
INDEPWA -1.115***
INDEPWA -7.284*
INDEPWA -21.511
GII 2.678***
GII 8.743**
GII 17.213*
INDEPWA -0.074 INDEPWA -1.604***
INDEPWA -9.074
GII 0.267
GII 2.888**
GII 10.892**** Significant at the 99 percent level. ** Significant at the 95 percent level. * Significant at the 90 percent level

Table 3 reports differences in elasticities across cases. It can be observed that marginal
elasticities of INDEPWA and GII are similar for a similar level of bargaining power between thegovernment and the bank (Table 3-the diagonal of the marginal elasticities: low GII-low
INDEPWA, medium GII-medium INDEPWA and high GII-high INDEPWA). In these cases, achange of relative power for the government and the bank will have a similar impact on theprobability of gold adherence. However, the magnitude of marginal elasticities differs when
we compare the different levels of bargaining power between actors. In the case of a mediumhigh level of government influence together with a low-medium level of bank independence,
marginal elasticities are small in magnitude, government marginal elasticity being higher thanbank marginal elasticity (Table 3- marginal elasticities below the diagonal: high GII-low
INDEPWA, high GII-medium INDEPWA and medium GII-low INDEPWA). This means that anincrease in bank independence would have a very small probability of abandoning gold
convertibility. Strong political institutions would guarantee gold adherence.
On the contrary, in the case of a low-medium level of government influence together with amedium-high level of bank independence, marginal elasticities are high in magnitude, bankmarginal elasticity being higher than government marginal elasticity (Table 3-marginal
elasticities above the diagonal: low GII-medium INDEPWA, low GII-high INDEPWA, medium GIIhigh INDEPWA). In this case, an increase in bank independence would have a very highprobability of abandoning the convertibility of gold as bank's aim is profit maximization andnot monetary stability. Strongly independent private central banks negotiating with weak
governments would avoid the responsibility of defending the currency even in a stable
macroeconomic situation.
Qualitative evidence confirms econometric results. State-bank power relations moved
gradually to a higher level of central bank independence together with a lower level ofgovernment strength (as we have measured in sections 2 and 3). As a consequence, monetarystability was sacrificed in favour of banking profitability. Two episodes were crucial. First, thebringing forward of the charter renewal from 1904 to 1891. Before the charter renewal, theBank of Spain had applied orthodox monetary policy oriented to maintain the exchange rate
within the gold points, that is, the Bank raised the interest rate to reduce the money supply

22
when the reserve ratio reduced in currency crises (Bloomfield 1959). Spain suffered a currency
crisis in both 1882 and 1891. In the first currency crisis, the Bank increased interest rates andreduced reserves. Interest rates increased from 4 to 4.5% in 1882 and from 4.5% to 5% in 1883.
Reserves were reduced drastically during 1882 (26% of silver reserves and 60% of gold
reserves). The Bank of Spain controlled the speculative attack of 1882 and the peseta remained
within the gold points. Once the peseta had been stabilized, the Bank reduced the interest rate
once more to the original level of 4%, and the interest rate did not change until the following
currency crises, during the period 1889-1891. In the second currency crisis, the Bank of Spain
increased interest rates (from 4% to 5% in 1891 and from 5% to 5.5% in 1892). Silver reserves
were reduced by 60% from 1888 to 1890 (gold reserves suffered only a minor reduction
because the Bank had gradually stopped converting banknotes to gold between the mid-1880s
and 1890) (Martinez-Ruiz and Nogues-Marco 2014, pp. 26-31). However, the increase in theinterest rate did not reduce the money supply because the change of issuing ceiling doubled
the maximum quantity of banknotes in circulation (from 750 to 1,500 million ptas; see Figure1) (Law 14 July 1891). From that moment on, the Bank of Spain stopped defending the peseta,
which started to float in August 1891, just a few days after the renewal of the charter (seeFigure 5).
The second episode was the fiscal reform implemented in 1899-1901 by the Ministry of
Finance – Villaverde, intended to restore order to Spanish finances after the 1898 Cuban War
of Independence, which substantially increased the independence of the Bank (see Figure 4).
Villaverde’s reform included a tax reform and a debt conversion plan. It was intended not only
to provide a definitive solution to the permanent fiscal deficit, but also to prevent the damages
that, in his view, debt monetization had inflicted on the international value of the peseta. In
this respect, the plan included firm measures to restrict the government's capacity to turn tocentral bank financing and the obligation of the State to repay the Bank all the loans received
to finance the War, considered by Villaverde a necessary preliminary step to undertake thenecessary reduction of the circulation of money to integrate in the gold standard. However, in
this occasion, the Bank of Spain did not cooperate with the government in seeking to restore
stability of exchange because the greater the depreciation of the exchange rate, the greater
were the paper profits of the Bank. The policy of the Bank of Spain was to offer loans
collateralized with sovereign debt at an interest rate lower than the yield earned by thesovereign debt itself, thereby encouraging speculators to borrow as much as possible bypledging sovereign bonds, use the loan to buy more public bonds and use them once again as acollateral for another loan to buy more public bonds, and so on (Conant 1915, p. 315-316).
Gold adherence was a political aspiration shared by the majority parties, but the way toachieve it was not entirely shared within the government, as part of the cabinet did notunderstand the emphasis Villaverde placed on monetary stability versus ensuring an easy
access to banks’ financial help.31 Even then, the President, Francisco Silvela, expressed doubts,
saying “I wonder whether Villaverde is a sort of deluded fool driven by the secret aim tosanitize the currency”.32 This was not uncommon during the period as party cohesion wasespecially weak in economic issues, since the interest of the represented group, region or even
31

Martinez Mendez (2005) Chapter 9.
Francisco Silvela (1904) cited in Martorell (2000)

32

23
company always prevailed over party voting discipline. 33 The lack of consensus over the
deflationist option was revealed two years later when the new Finance Minister, Ángel Urzáiz y
Cuesta, tried to complete the reform of Villaverde by imposing a reduction of the issuing limits.
Urzáiz's purpose was to decrease the amount of banknotes in circulation to improve exchange
rate and gold premium, ranging at the time between 37 and 40 premium. He laid much stresson the imperious necessity for Spain to take thus the first steps in the direction of a sounderpolicy in its currency and in its excessive banknote issue.34 The negotiation process was intense.
According to The Economist "the board of directors [of the bank of Spain] had a hard fight withthe liberal finance ministers, who were backed by public opinion, by commercial and financial
circles, by the Press, and even by the Opposition Statesmen and ex-ministers of finance in the
Parliament".35 Bank resistance to surrender and the lack of uniform criteria in government
ranks caused the fall of several ministers in less than five months. At the same time, for several
months in 1902, no new governor could be appointed at the Bank of Spain following theresignation of the former one, due to the strong opposition of the Bank Board to abide by theconditions of the government in negotiating the new agreement that aimed at reducing
banknote issuing. 36 The final result was a new legal framework for the Bank of Spain (Law 13
May of 1902 and Agreement 17 July 1902) that made it more difficult for the government toaccess central bank financing, while at the same time ensuring it was cheaper, but did not
manage to reduce issuing ceiling (see Figure 1). The Law was considered in the press and in
business circles as a triumph of the interests of the bank against general interests.37
From that moment on, the Bank of Spain blocked currency stabilization despite government
attempts to adopt gold standard. In June 1903, the Finance Minister presented to Parliament
two bills which he deemed likely to improve the monetary situation, particularly in connection
with foreign exchanges and the value of the Spanish currency. 38 In September 1903, theFinance Minister considered that "the time had come to attend, if possible, to foreignexchanges, to the currency, the fiduciary circulation, the relations of the Bank of Spain and theTreasury, and to the administration and guarantees of the Bank itself, that he deemed
insufficiently reformed by the law voted by the Parliament in 1902". The goal was to reduce
silver and notes in circulation as the best means to promote the return to a gold standard andgold currency. The Economist recognized that "Mr. Villaverde [being President of theGovernment in that moment] is gamely trying to grapple with some of the most difficult
problems that Spanish Governments and Spanish Finance Ministers have been confronted withfor years. His efforts are viewed with favour by the commercial and industrial classes. But as
the success of his financial policy depends, as usual in Spain, upon the length of time that he33

Martorell Linares (2012). The article includes a very illustrative citation on this issue by the influential congressman
Baldomero Argente, who said in 1914, "economic affairs are not matters of dogma, are not fundamentally party
issues".
34
The Economist, "Spanish Finance and Currency", July 13, 1901, issue 3020, pp. 1044-1045
35
The Economist, "The Report of the Bank of Spain for 1902", April 4, 1903, issue 3110, pp. 605-606
36Bank of Spain. Archives, Minutes of the Board of Governors Meetings (1902). The new governor was finally named
after the signing of the new agreement
37
Luque Castillo (2014), p. 104-105
38
The Economist, "The Spanish Budget", June 27, 1903, issue 3122, pp. 1128-1129

24
will command enough favour at Court to counteract the many political influences at work, evenin the ranks of his own Conservative party"39
Between 1903 and 1913, at least four bills which aimed at stabilizing the exchange rate andpreparing Spain for the integration of the gold standard were presented at the Bank of Spain.
All these projects faced the Bank's opposition and led to crude confrontations between thegovernment and the Bank. Shareholders expressed some concern and displeasure at the
decline in the value of their shares, which took into account the inevitable consequence of thesteady decrease, since 1900, of the relations of the Bank with the State and Treasury. 40 Due tothe incapability of the State to persuade the Bank to assume the objective of stabilizing theexchange rate within the gold points, the government proposed the creation of a special fundstyled "Fund of Exchange" co-financed by the State and the Bank to regulate and improve
international exchange. This project was also unsuccessful, and the premium on gold rose toalmost 6.75 on Paris in December 1912.41 The last legislative attempt to speed the integrationof the peseta into the gold standard was made in May 1914. The gold standard was neverresumed because the Bank of Spain was sufficiently independent and therefore could rejecttaking the necessary steps even after the successful fiscal consolidation.

Conclusions
This article contributes to the literature on central bank independence and monetary stability
during the classical gold standard era. On the eve of the First World War, European central
banks had achieved a high degree of protection against political pressures to monetize debt.
Central bank independence was the endogenous outcome of negotiations that codified statebanks relations when charters were drafted and adjusted over time following actual changes inunderlying power relation.
North-western European countries enjoyed stable gold adherence, while central-eastern andsouthern European countries were unable to commit to long-lasting gold adherence despite
gradually increased central bank independence. In this paper we have explored state-bankpower relations to explain the relationship between central bank independence and monetarystability in peripheral Europe. Concretely, we have focused on the case of Spain. State-bankpower relations and its changes over time have been measured by combining indexes on
central bank independence together with estimations on the degree of strength of politicalinstitutions.
Results have shown that both central bank independence and political strength are significant
variables in explaining long-lasting gold adherence. Higher central bank independence did not
generate monetary stability. On the contrary, central bank independence is negatively
correlated with gold adherence. Nowadays, central bank independence theory assumes thatthe objective function of central bank is monetary stability, so greater independence means

39

The Economist, "Spanish Finance", September 5, 1903, issue 3132, pp. 1535-1537
The Economist, "The Bank of Spain", March 18, 1905, issue 3212, pp. 442-443
41
The Economist, Reforms in Spain and a Loan", December 28, 1912, issue 3618, pp. 1329-1330
40

25
higher monetary stability. But this statement is not valid historically because the bank of Spain
was a private institution whose main goal was profitability and not monetary stability.
Monetary stability was a political goal. Effectively, results show a positive correlation between
political strength and gold adherence. More important, our results confirm that a highly
independent private central bank avoided the responsibility of defending gold adherence whennegotiating with weak government, even in a context of fiscal consolidation.
Our research suggests that the success of central bank independence in generating monetarystability during the gold standard period depended on sound political institutions. Goldadherence required austerity policies to deflate the economy. Then, as now, policies oriented
to fiscal consolidation and monetary adjustment needed strong political institutions capable toimplement them successfully.

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30

Appendix
Table A1: Government influence variables and their coding
POLITICAL STABILITY (POLSTAB)
1.5

Presidential term of office
The bigger the turnover, the less stable the government

1913

1910

1907

1904

1901

1898

1895

1892

1889

1886

1883

1880

1877

Too 2

0.4

1913

1910

1907

1901

1898

1895

1892

0.0

1889

0.2
1886

1
0.75
0.5
0.25
0

1883

1 ≥48
2 48>too≥24
3 24>too≥12
4 12>too≥6
5 <6

0.8
0.6

1880

Too2=
Ministry of Finance term of office

0.0

1904

Ministry of Finance term of office
The bigger the turnover, the less stable is economic policy

0.5
1874

1
0.75
0.5
0.25
0

1877

1 ≥48
2 48>too≥24
3 24>too≥12
4 12>too≥6
5 <6

1874

Too1=
Presidential term of office

Too 1

1.0

31

Fiscal balance /GDP *Significance of financing by the central bank
The bigger the share of debt placed in the Bank of Spain, the more
dependent the government will be on its central banker
CB financing

Public debt on Bank of Spainbalance sheets/total public
debt *

External debt
The greater the external debt, the more freedom the government will
have to choose the optimal portfolio for funding public debt.
Extdebt

Ext Debt/Total Debt **Notes: 1 maximum influence, 0 minimum influence*Normalized as 1-[(yi yeart – yi max ) / ( yi min – yi max)]**Normalized as (yi yeart – yi min ) / ( yi max – yi min)
Sources: DEF: Comín and Díaz Fuentes (2005) SERIE 2790 and Carreras, Prados de laEscosura and Roses (2005) SERIE 4411; CB financing: Annual Report Bank of Spain (18741914) and Comín and Díaz Fuentes (2005) SERIE 2894; EXTDEBT: Comín and Díaz Fuentes(2005) SERIES 2887 and 2894

1.2
1.0
0.8
0.6
0.4
0.2
0.0

1.2
1.0
0.8
0.6
0.4
0.2
0.0

1874
1877
1880
1883
1886
1889
1892
1895
1898
1901
1904
1907
1910
1913

Def

Def

CBﬁnancing

1874
1877
1880
1883
1886
1889
1892
1895
1898
1901
1904
1907
1910
1913

Annual net borrowing of the state
The bigger the deficit, the less able will the government be to impose
conditions on other economic agents

1.2
1.0
0.8
0.6
0.4
0.2
0.0

Extdebt

1874
1877
1880
1883
1886
1889
1892
1895
1898
1901
1904
1907
1910
1913

FINANCIAL SITUATION (FINANSTR)

32
Table A2. List of criteria for legal independence, weighted average (LIWA)
CHIEF EXECUTIVE OFFICERS (CEO)Who appoints?
The greater the authority the government has to appoint, the less independent will be the central bank

1
App1=
Who appoints governor?

1
2
3
4
5

Central bank board
Council composed of members from executive andlegislative branches
Parliament
Council of Ministers
Prime Minister or Minister of Finance

0.75
0.5
0.25
0

Who dismisses and why?
The greater the authority of the government to dismiss and the more arbitrary its capacity, the less independent will be thecentral bank

Diss1=
Provision for dismissal of Governor

1
2
3
4
5
6
7

No provision
Only possible for non-policy reasons
At discretion of CB board
For policy reasons at discretion of Parliament
Unconditional at discretion of Parliament
For policy reasons at discretion of Government
Unconditional at discretion of Government

1
0.83
0.67
0.5
0.33
0.17
0

POLICY FORMULATION (MONPOL)
Who formulates central banking policy?
The greater the responsibility in the formulation of central banking policy, the more independent will be the central bank

Formpol=
Who formulates policy?

1
2
3
4

CB alone
CB + Government together
CB advises/proposes; government decides
Government alone

1
0.66
0.33
0

How are conflicts resolved?
The greater the capacity to oppose/resist government orders and/or suggestions, the more independent will be the central
bank

1
Conf=
Resolution of conflict

2

3
4
5
6

CB given authority over issues clearly defined as CB
objectives
Government has final authority only over policy
issues that have not been clearly defined as CB
goals or in case of conflict
In case of conflict the final decision is up to acommon council
Parliament has final authority on policy issues
Government has final authority on policy issues but
subject to due process and possible protest by CB
Government has unconditional authority

1
0.8

0.6
0.4
0.2
0

33
LIMITATIONS ON GOVERNMENT LENDING
Limitation on advances
The more binding/strict the limitations, the more independent will be the central banklla=Limitation on advances (de iure)

1
2
3
4

Prohibited
Limits in terms of absolute cash or to other typesof relatively strict limits
Limited, specified as a percentage of CB capital orother liabilities
No limitation

1
0.66
0.33
0

Limitation on securitized lending
The more binding/strict the limitations, the more independent will be the central bankProhibited
Limits in terms of absolute cash or to other typesof relatively strict limits
3 Limited, specified as a percentage of CB capital orother liabilities
4 No limitation
Who sets the general terms of borrowing?
lls=
Limitation on securitized lending(de iure)

1
2

1
0.66
0.33
0

The more regulated or the stricter the restriction, the more independent will be the bank from pressures to give morefavorable conditions to the state

CB controls terms and conditions
Terms specified by law or CB given legal authority
to set the terms
3 Law leaves it to negotiation between both
4 Government controls terms and conditions
Limitations on maturity and/or interest rates
ldec=
Who sets the general terms ofborrowing?

1
2

1
0.66
0.33
0

The more regulated or the stricter the restriction, the more independent will be the bank from pressures to deviate
resources to the state

lmat=
Limitations on maturity

lint=
Limitations on interest rates

1
2
3
4
1
2
3
4
5

Limited to a maximum of 6 months
Limited to a maximum of 12 months
Limited to a maximum of more than 12 months
No legal upper bounds on maturity
Interest rate on CB loans must be at market rate
Interest rate on CB loans cannot be lower than acertain ceilingInterest rate on CB loans cannot exceed a certain
ceiling
No legal provision regarding interest rate on CB
loans
Law stipulates no interest rate charge

Note: 1 maximum independence, 0 minimum independence.

1
0.66
0.33
0
1
0.75
0.5
0.25
0

34
APP1 and DISS1: throughout the study period the Governor of the Bank of Spain was
appointed directly by the Minister of Finance, who could also dismiss him at any time. The
governor was therefore seen as a trusted political officer of the incumbent government.
Consequently, no legal term of office was contemplated in law, since it was understood thateach minister would appoint his own trusted person for such an important office.42 For thatreasons, the code assigned to both legal proxies is 0, signifying total dependence.

1914

1910

1906

1902

1898

1894

1890

1886

1882

Diss1

1878

1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0

1874

1914

1910

1906

1902

1898

1894

1890

1886

1882

1878

App1

1874

1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0

FORMPOL and CONF: The Bank of Spain was completely free to set the interest rate. With
regard to discount rates, the normal operational mode in the period analysed was that interest
rates changes were decided in the Bank of Spain's Executive Council, normally on its own
initiative. As time went by the government, usually through the governor, began to makeexplicit indications on the issue.43 From 1901 on the government was in fact much more prone
to make suggestions to the Bank about the appropriate course of action. In 1902 thegovernment even tried to usurp the power to set the interest rate, with no success.
The fact that very often the Minister of Finance suggested ("invited" in the florid language ofthe correspondence between the Bank of Spain and the Ministry) that the Bank adopted aparticular measure has sometimes been interpreted as a total submission of the central bankto government wishes. 44 In this respect some qualifications are necessary. Firstly, it isimportant to bear in mind that government suggestions were not always followed andfrequently aroused heated arguments among the members of the council. The result of suchdiscussions was in many cases determined by the character of the personalities involved,
mainly the governor and the deputy governors, and thus it is essential to pay attention toactual practice.45 Secondly, as Martínez Méndez (2005) has pointed out, the suggestions of the42

A measure of the legal term of office is not included in our index precisely because it does not exist as such.
Actually it was the executive commission who proposed such changes, while the council usually just ratified thedecisions of the commission.
44
See, among others, Martínez Mendez (2005), who states: "The vision that seems to prevail in the political sphereis that the Bank of Spain was a mere executor of decisions defined once and for all"45
On occasion of the increase of the discount rate in 1903, Sanchez Guerra, then Bank of Spain governor, wrote to apolitical fellow "For days I've been fiddling about between the desires of the President and the resistance, passive
43

35
Treasury were in many cases obviously the result of prior negotiation, as the text, full of jargon
and technical considerations, appeared to be drafted by the Bank's own officers.
In short, given the lack of clear legal dispositions, it was essential to turn to actual practice todetermine the degree of prominence of each actor in monetary policy decisions. After
analysing each decision in this respect, taken during the 40 years of our study period, we haveassigned a code of 0.66 to Formpol as we consider that there is evidence of a more or lessequal implication of the two actors in the decision process. In the same way, the resolution of
eventual conflicts was always the result of negotiations between the Bank of Spain and thegovernment. Far from being docile, the Bank of Spain usually employed every weapon at its
disposal to defend its position. For that reason, we have assigned a code of 0.6 to Conf.
0.7

0.7

0.6

0.6

0.4

Conf

0.5
0.4

0.3

0.3

0.2

0.2

0.1

0.1

0.0

0.0

1874
1877
1880
1883
1886
1889
1892
1895
1898
1901
1904
1907
1910
1913

Formpol

1874
1877
1880
1883
1886
1889
1892
1895
1898
1901
1904
1907
1910
1913

0.5

LLA, LLS, IDEC, LMAT and LINT: The terms and conditions of government borrowing from the
Bank were not established in any legal text, but subject to negotiations, the results of whichwere published in the form of agreements signed by the two institutions. In fact, the legal
configuration of the financial relations with the state can be defined as vague, rendering it
more important to examine actual practice in greater detail. That means to determine to what
extent those agreements were imposed on the Bank or instead were agreed to. Intuitively, thisambiguous framework enhanced government chances of imposing financial arrangements on
the Bank. When looking at the evidence provided by the Bank's council minutes and otherinternal discussion forum though, we find that, although the State had a stronger bargaining
chip in this matter, the Bank had also good opportunities to assert its position and rarely adecision was taken if the Bank considered it damaging to its economic interests. Consequently,
as the general conditions of the borrowing were the result of prior negotiation, we assigned acode 0.33 to ldec proxy, with no changes during the period.
As for the remaining variables during the studied period two different periods are to be
distinguished. From 1874 to 1901, the regulations about the advances and securitized lending
limited the capacity of the State to resort to the Bank of Spain to a percentage of CB paid-up
capital (100%) and never without "solid guaranties". 46 The agreement signed in 1891 on
and active, of the ...Council to achieve... the elevation of the discount rate and the loans to 4.50%. We'll see if it
gives the result that the government promises? ". Cited in Martorell Linares (2011)46
Martínez Pérez (1922) , p. 7

36
occasion of the charter renewal obliged the Bank to give an advance every year up to a
maximum of 75 million ptas (50 percent of paid up-capital). In this sense, although a restriction
existed, it was not a very binding one, and thus we have assigned a code of 0.33 to lla.
Securitized lending was forbidden and thus a code of 1 has been assigned to lls. As it will be
explained later, this prohibition was not respected from 1874 to 1901, and that fact wasrecognized in the fiscal reform of 1901.
In fact, there is a clear break in this respect in 1901, when the Minister of Finance, Fernández
Villaverde, launched an ambitious fiscal reform in an attempt to rationalise spending and tomodernise the fiscal structure that was accompanied by a drastic conversion of the debt.
Villaverde's fiscal consolidation plan included resolute measures to restrict government
capacity to turn to central bank financing. The result was a law (13 May 1902) that establisheda new legal framework for the Bank of Spain. Consequently, the Treasury committed itself torepaying the Bank the amount of the long term credits from external debt within 10 years. The
limits to securitized lending were therefore established in terms of absolute cash, which gavethem a relatively binding character, but and less strict one than the former prohibition, so thatfrom 1902 on a code of 0.66 has been attributed to lls. As for the advances, the government
committed itself to not receiving advances other than those provided for in the 1891
agreement. This decision made the limitations stricter, so that from 1902 on a code of 0.66 has
been assigned to lla.
The opposite was true for the dispositions on interest rates. From 1874 to 1891 there was no
specific disposition in legal texts concerning the interest rate to be charged to the government.
Consequently, the interest charged was the result of negotiation. Accordingly, lint received acode of 0.5 in this period. On the contrary, in the 1891 agreement the government included aclause that established that new advances were to be charged at an interest rate "equal to(the) lowest of those charged to the operations carried out by the Treasury". Furthermore, in a
new agreement signed on 17 July 1902, the interest rate to Treasury bonds was fixed at 2
percent and it was established that it could be reduced when required by "extraordinary
circumstances". The capacity of the Bank to set the interest rates of its advances and otherlending to the government declined and consequently the code assigned has been reduced to
0.25. As for the maturity of borrowing until 1901, the Bank had no capacity to influence that
aspect of lending. Again the new agreement of 1902 attributed to the Bank the establishmentof the maturity of loans.

0.7

0.35

0.6

0.30

lla

Idec

0.25

1914

1910

1906

1902

1898

0.00

1894

0.05
1890

0.1
0.0

1886

0.10

1882

0.15

0.2

1874
1877
1880
1883
1886
1889
1892
1895
1898
1901
1904
1907
1910
1913

0.3

1878

0.20

0.4

1874

0.5

0.0
1878

1914

1910

1906

1902

1898

0.8

1894

1.0

1890

1886

1882

0.0

1.2

lmat

0.6

0.4

0.2
1914

0.5

1910

0.6

1906

1902

1898

1894

1890

1886

1882

1878

lls

1874

1870
1874
1878
1882
1886
1890
1894
1898
1902
1906
1910
1914

1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0

1874

37

lint

0.4

0.3

0.2
0.1

38
Table A3. Criteria list for extended legal independence, weighted average (ELIWA)
CHIEF EXECUTIVE OFFICERS (CEO)Who appoints?
The greater the authority the government to appoint, the less independent will be the central bankApp2=
Who appoints sub-governor?

1
2
3
4
5

Central bank board
Parliament
CB board proposes candidates, Council of Ministers
choosesCouncil of Ministers
Prime Minister or Minister of Finance

1
0.75
0.5
0.25
0

Who dismisses and why?
The greater the authority of the government to dismiss and the more arbitrary its capacity, the less independent will be thecentral bank

Diss2=
Provision for dismissal of deputy
governor

1
2
3
4
5
6
7

No provision
Only possible for non-policy reasons
At discretion of CB board
For policy reasons at discretion of Parliament
Unconditional at discretion of Parliament
For policy reasons at discretion of Government
Unconditional at discretion of Government

1
0.83
0.67
0.5
0.33
0.17
0

Table A4. Weights used in the aggregations for legal independence, weighted average (LIWA)
Criterion

1

CEO

2

MONPOL

3
4
5
6

Limits to advances
Limits to lending
General terms of borrowing
Conditions of lending

Variables
considered ineach criterion
app1
diss1
formpol
confl
lla
lls
ldec
lmat
lint

Aggregation

Weights

unweighted

0.25

0.66
0.33
No
No
No
unweighted

0.20
0.15
0.10
0.15
0.15

39
Table A5. Weights used in the aggregations for extended legal independence, weighted
average (ELIWA)
Criterion

1

CEO

2

MONPOL

3
4
5
6

Limits to advances
Limits to lending
General terms of borrowing
Conditions of lending

Variables
considered ineach criterion
app1
diss1
app2
diss2
formpol
confl
lla
lls
ldec
lmat
lint

Aggregation

Weights

unweighted

0.25

0.66
0.33
No
No
No
unweighted

0.20
0.15
0.10
0.15
0.15

APP2 and DISS2: In the period analysed there were two Deputy Governors, first and second.
The government bore the authority to appoint both of them, although they were required to
be chosen from among the 3 persons proposed by the bank’s council. In most cases, theappointment of the first DG went to the second DG at that time, making the renewal of thetwo positions simultaneous. The second DG was usually chosen from among the top officials of
the Bank. This means that the DGs came from the bank's management and had spent a longcareer in Parliament, culminating in their appointments. Appointments were for life, so that inmany cases the substitution of the DG was the result of death. In other cases, the person in
charge resigned for health or age considerations. No one was dismissed by the government inthis period, even though the executive had the legal power to do so. Therefore, App2 andDiss2 have a coding of 0, while App2 has received a 0.5 coding.

1.0
0.8

App 2

Diss 2

0.6
0.4

1914

1910

1906

1902

1898

1894

1890

1886

1882

1878

0.0

1874

1914

1910

1906

1902

1898

1894

1890

1886

1882

1878

0.2
1874

0.6
0.5
0.4
0.3
0.2
0.1
0.0

40
TOO3 and TOO4: In the years analysed, changes in the governor did not coincide exactly withthe change of government or Minister of Finance, in many periods there was not even a
general coincidence. Between 1 January 1874 and 31 December, 34 governors of the Bank of
Spain were appointed, although 9 of them were appointed twice, which counterbalanced thehigh turnover rate to a certain extent. This gives an average duration of office of about 14
months. However, it must be noticed that in the first years, 3 governors (Martín Belda, Romero
Ortiz and Salvador de Albacete) had relatively long terms, holding the position for 38, 31 and65 months respectively. Furthermore, between 1892 and 1895, Pío Gullón was Governor for
28 months. No other governor had a term of longer than five years. One governor lasted only
37 days, and in 1905 the office was unoccupied for over five months. The code has been
assigned according to the length of the term. Since the idea is that, in order to be able topursue long-term objectives, the governor needed to remain in his post longer than thegovernment an initial threshold has been established at 6 years.47 Any year with a governor
remaining in the post longer than 6 years has received a code of 1. The length has then been
gradually reduced to less than 4, 2 and 1 years. In the case that the governor lasted less than
12 months a code of 0 has been allocated.
As for the deputy governor, from 1 January 1874 to 31 December 1914 only 6 persons
occupied the position of first DG; of these 5 had been the second DG immediately before.48
The first DG had a mean of almost 9 years in office, and 2 of them were in their posts for over
15 years. The lengthy permanence of the DG and their great influence effectively decoupled
the decisions of the Bank from political events, giving stability to the institution. In the same
way as for the governors, a code has been assigned according to the length of the term of thefirst DG ranging from 0 (less than a year), to 1 (over 6 years). The coding is 1 for every year,
except for the 1902-1911 period where 6 years was awarded a code of 0.5 and the remaining
years a code of 0.75.

1.0
0.8

Too 3

0.6
0.4
0.0

1874
1877
1880
1883
1886
1889
1892
1895
1898
1901
1904
1907
1910
1913

0.2

1.2
1.0
0.8
0.6
0.4
0.2
0.0

Too 4

1874
1877
1880
1883
1886
1889
1892
1895
1898
1901
1904
1907
1910
1913

1.2

Clla and Clls: These variables account for the actual compliance with the limitations on
advances and securitized lending. After calculating the existent amounts of advances andpublic debt in the Bank's portfolio, we compared them with the legal limits. A code of 1 was
attributed to those years when the limits were observed and a 0 code when they were not (seeTable A7 of the Appendix).
47
48

As will be shown below the maximum duration of a government was 5 years.
Only the first DG of the period studied, José González Breto, had not been a second DG before.

41

1.2

1.2

clls

1.0
0.8

1.0

clla

0.4

0.2

0.2

0.0

0.0

1874
1877
1880
1883
1886
1889
1892
1895
1898
1901
1904
1907
1910
1913

0.6

0.4

1874
1877
1880
1883
1886
1889
1892
1895
1898
1901
1904
1907
1910
1913

0.8

0.6

Table A6. Simple correlation and Spearman rank correlation weighted and unweighted index
of legal independence
Simple correlation
LIUA
LIUA
1
LIWA
0.995
ELIUA
1
ELIWA
0.995

LIWA

ELIUA

1
0.995
1

1
0.995

ELIWA

1

Spearman rank correlation
LIUA
LIWA
LIUA
1
LIWA
1
1
ELIUA
1
1
ELIWA
1
1

ELIUA

ELIWA

1
1

1

Table A7. De facto criteria list for INDEPWA
CHIEF EXECUTIVE OFFICERS (CEO)Term of office

The longer a governor stayed in office, the more able was he to resist the pressures of the executive branch and/or to
implement longer term policies

1 ≥72 months
2 72>too≥48
3 48>too≥24
4 24>too≥12
5 <12 months
Too4=
1 ≥72 months
Term of office of deputy governors 2 72>too≥48
3 48>too≥24
4 24>too≥12
5 <12 months
LIMITATIONS ON GOVERNMENT LENDING (LEND)
clla=
1 Yes
Compliance with limitation on
2 No
advances (de facto)
clls=
1 Yes
Compliance with limitation on
2 No
securitized lending (de facto)
Too3=
Term of office of governors

1
0.75
0.5
0.25
0
1
0.75
0.5
0.25
0
1
0
1
0

42
Table A8. Weights used in the aggregations for INDEP
1

CEO

2

MONPOL

3

Limits to advances

4

Limits to lending

5
6

General terms of borrowing
Conditions of lending

app1
app2
diss1
diss2
Too3
Too4
formpol
confl
lla
clla
lls
clls
ldec
lmat
lint

Aggregation
unweighted

Weights
0.25

0.66
0.33
unweighted

0.20

unweighted

0.10

unweighted

0.15
0.15

0.15

Table A9. Simple correlation and Spearman rank correlation weighted and unweighted index
of independence
Simple correlation

Spearman rank correlation

INDEPWA INDEPUAINDEPWA1

INDEPUA

1

1

INDEPWAINDEPWA1

INDEPUA

0.968

INDEPUA

1