1988 Oxford Economic Papers  
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more » ... enback price of the gold dollar ranged from par to 2.5 (see Fig. 1 ). The monetarist explanation for these exchange rate movements espoused by Friedman and Schwartz (1963) views the supply of greenbacks and the growing real demand for money as the sources of domestic price movements and, through them, the depreciation and subsequent appreciation of the currency. A different explanation provided by Mitchell (1903 Mitchell ( , 1908 and Studenski and Krooss (1963) argues that expectations regarding government fiscal policy and fiscal shocks (e.g., battle reports), which affected the probability and expected timing of resumption of specie convertibility, caused changes in current exchange rates and prices. Recent theoretical contributions by Sargent and Wallace (1981), among others, have demonstrated the potential importance of fiscal expectations for determining the current level of prices and exchange rates. For example, an expectation of fiscal profligacy may imply future money supply growth and inflation which causes the current level of real money demanded to decline; thus for a given level of current money supplied, the price level rises and the currency depreciates. Assuming the market in which currencies are traded operates efficiently, movements in the exchange rate properly track news of changes in expected government policy. Evidence from currency and securities markets (discussed below) indicates that mid-nineteenth-century American financial markets responded to expectations of government policy changes in a manner consistent with market efficiency. In applying the Sargent-Wallace approach to the history of greenback exchange rate determination, however, one must take account of institutional peculiarities of the period. First, for most of the period of suspension the supply of paper high-powered money was not held fixed by the government; national banks were authorized to supply a perfect substitute for greenbacks in the form of national bank notes. From mid-1870 on bank notes rather than greenbacks were the marginal component of the paper high-powered money supply. Second, the potential for a return to promised gold dollar parity meant that expectations of fiscal * I would like to thank
doi:10.1093/oxfordjournals.oep.a041884 fatcat:yvz5viffcva3xlu426qlsrtaka