It is difficult to find clear precedents for today's Economic and Monetary Union (EMU), currently encompassing 17 EU member states. Historically, there have been three types of monetary union:
The Austro-Hungarian Dual Monarchy arose from the political crisis that followed the military defeat of the Austrian Hapsburg Empire by Prussia in 1866. Imperial weakness offered Budapest's Magyar elite an opportunity to wrest major concessions from the Empire by threatening secession. To prevent this Vienna and Budapest agreed the 'Compromise of 1867', a constitutional treaty that recognised the sovereign autonomy of Austria and Hungary under a single monarch - the Austro-Hungarian Dual Monarchy. Each sovereign nation had its own parliament, administration, budget and national debt. But both nations shared a head of state, armed forces, foreign policy and diplomatic representation, and legal system. On the economic front, they formed a customs union and both continued to use the pre-Compromise currency - the Austrian silver shilling - while the pre-Compromise Austrian National Bank continued to be the single bank of issue. With a common currency and common national bank, the dual monarchy amounted to a form of monetary union.
This combination of independent sovereign political and fiscal arrangements along with joint monetary structures has notable similarities to the euro area. However, the dynamics of the creation of these two 'single currency, separate governments' monetary unions were diametrically opposite. The euro area is a voluntary convergence of states that have created new common monetary arrangements (a dynamic akin to the currency alignments in the Latin Monetary Union and Scandinavian Monetary Union); but the Austro-Hungarian monetary union resulted from a political separation, producing independent sovereign states with continued common monetary arrangements. Nevertheless, despite their different origins, the outcomes have much in common as do their issues and dilemmas.
The Austro-Hungarian monetary union operated for almost fifty years without serious disruption, during which time income per head doubled. As agreed in 1867, the terms of the Compromise were reviewed every ten years and adjustments were made to liabilities for common expenditures and other matters. Monetary, institutional and budgetary development can be divided into three broad phases, followed by a final coda triggered by war. The first phase, from 1867 to the early 1890s, saw significant monetary instability and fiscal indiscipline. The second, which commenced in 1892, featured a number of important monetary reforms including the introduction of a gold coinage, the Austro-Hungarian crown. The third began in 1896 with Austria-Hungary pegging its currency to the gold standard, which along with other measures ushered in a period of monetary stability and prudent fiscal housekeeping. The 1890s saw the emergence of an authoritative, independent-minded central bank that became the lynchpin of the Austro-Hungarian monetary union, though this did not preclude political confrontations. The final phase opened in 1914 with the outbreak of the First World War, resulting in the defeat and breakup of Austria-Hungary in 1918 and the demise of its common monetary arrangements.
The Austro-Hungarian monetary union inherited the monetary arrangements of the Austrian Hapsburg Empire.
The currency comprised silver florins, as well as a large volume of inconvertible notes issued by both the Austrian National Bank and by the Hapsburg imperial government, whose supply had swollen to finance war with Prussia. The Compromise provided for the inconvertible government paper money to remain in circulation with the joint guarantee of both parts of the dual monarchy. But there were to be no further government note issues. By a separate agreement, the Austrian National Bank remained the sole government bank and retained its monopoly over the issuance of bank notes. Despite Austria-Hungary's political and budgetary bifurcation, there remained one currency and one proto-central bank.
The Austrian National Bank was a private institution under government charter established at the end of the Napoleonic Wars. Headquartered in Vienna, it made advances to the imperial government, was the only bank of issue, and was responsible for stabilising Austria's currency. Along with the Compromise, the Hungarians demanded a greater hand in the management of the Austrian National Bank, threatening instead to establish a separate National Bank of Hungary. The coincidence of the expiry of the Bank's charter with the first renegotiation of the Compromise in 1877 forced a solution. In 1878 the Austrian National Bank became the Austro-Hungarian Bank, with enhanced Hungarian control. The Austro-Hungarian Bank was a bilingual institution with operating arms in both Budapest and Vienna, as well as a central office in Vienna, and acted as the bank of issue for both countries. The governor was appointed by the Emperor upon joint nomination by the finance ministers of Austria and Hungary. The Austro-Hungarian Bank now became a more bipartisan entity: in 1878, there were just five Hungarian branches out of 23 (21%); in 1888, 19 out of 50 (38%); and in 1900, 29 out of 69 (42%). The new arrangements worked well and the Bank enhanced its skills and self-assurance, equipping it to undertake sophisticated central banking functions.
A combination of factors, notably the global depreciation of silver, monetary instability arising from the large volume of outstanding inconvertible government notes, and both countries' increasing indebtedness, led to substantial volatility in the floating Austro-Hungarian currency in the 1880s. With reserves of only 20% of circulating paper, the Austro-Hungarian Bank was unable to stabilise the exchange rate. When its charter was renewed in 1887, it was thus required to raise its reserves to 40% of paper issues, like the German Reichsbank previously - though this was easier demanded than done.
The second phase of monetary union began in 1892, with the coordinated instigation by both governments of comprehensive monetary reforms intended to stabilise the currency and promote greater fiscal discipline. Legislation provided for a new gold Austro-Hungarian crown and it was resolved to move to the gold standard by 1900. The two governments undertook to repurchase the outstanding pre-Compromise government notes for gold, which was paid into the Austro-Hungarian Bank boosting its reserves. The sterilisation of government paper began in 1893 and was resolutely pursued despite the significant cost, with Austria funding 70% of the programme and Hungary 30%. Furthermore, the coinage of silver florins for government account was discontinued.
The reforms of 1892 removed the ability of the governments of Austria and Hungary to create money, greatly strengthening the control of the Austro-Hungarian Bank. Emboldened, the Bank maintained that to fulfil its mandate to maintain the external value of the currency it had to strictly limit advances to both treasuries. This assertion of independence, as well as other frictions, led to tense relations between the Bank and the political authorities in the mid-1890s. The two governments each demanded greater control over the Austro-Hungarian Bank in return for the Bank's enhanced power over monetary arrangements. The Bank robustly resisted, maintaining that no further restraint on its independence was warranted since the alleged loss suffered by the governments was, in fact, a gain in currency credibility. The episode plainly has echoes of the various proposals by politicians to curb the independence of the ECB - and the rejoinders.
As the sterilisation programme proceeded, the Bank accumulated gold. By early 1896 it had sufficient reserves to provide an effective cover ratio above the 40% statutory minimum. Though still at loggerheads with the governments, the Austro-Hungarian Bank boldly proceeded unilaterally with the stabilisation of the currency by implementing a 'shadow' gold standard, using open market operations to buy or sell Austro-Hungarian bills to hold the exchange rate of the crown around the adopted parity. Although Austria-Hungary never formally adopted the gold standard, the currency was effectively pegged to gold from 1896 until the war.
The threat of the establishment of a separate National Bank of Hungary revived in the run up to the renewal of the Austro-Hungarian Bank's charter in 1899. It was defused by further changes in the statutes providing Hungarian interests with full parity in the management of the Bank. This was disproportionate, given Austria's significantly larger population and much larger GDP, but Austria was prepared to pay this price to maintain the advantages of the Austro-Hungarian Bank's combined critical mass and to forestall the potential breakdown of the monetary union. Yet another threat to create a separate National Bank of Hungary arose in 1905 with the coming to power in Budapest of an Independence Party administration: the Austro-Hungarian Bank was accused of discrimination against Hungarians in its lending practices. The Bank substantially increased its provision of credit to the Hungarian provinces, winning the backing of provincial businessmen who then feared that these facilities might be withdrawn if Hungary went its own way. Moreover, Budapest bankers worried that secession would lead to higher interest rates in relatively backward Hungary and that the prized currency stability achieved by the Austro-Hungarian Bank would be endangered. Reservations about independence contributed to the disintegration of the nationalist administration in 1910: the Austro-Hungarian Bank was then awarded a renewed charter under which it operated until its liquidation after the war.
The 1867 Compromise established a two-tier fiscal system, with a 'confederate level' and a 'country level' - as with the EU. The customs revenues were hypothecated to fund the dual monarchy's confederate level expenditures (military spending wolfed 90%). Customs receipts proved insufficient and had to be supplemented by payments from the 'country' level budgets of the two governments, as confederate deficits were banned. Their respective contributions to the residual deficits were assigned roughly two thirds to Austria and one third to Hungary. No new confederate level loans were raised after 1867 and the outstanding pre-1867 debt was covered by an amortisation scheme (to pay off the principal, as well as interest, over time).
At the 'country level', each national government decided its own expenditures and taxes as voted by its parliament. The country budgets were not required to balance and in the second half of the 1870s and the 1880s both countries had substantial deficits, averaging around 10-20% of government revenue, but with dizzy fluctuations. Austria's deficit spiked at 70% in 1884 but plummeted to 2% the following year, while Hungary's spiked at 40% in 1891 but was in surplus in 1892. The deficits were funded by borrowing, as was substantial infra-structure investment. Hungary promptly used its new autonomy to raise large loans for railway building, mostly through overseas bond issues. Austria did likewise from 1875, with the 1880s witnessing a large, substantially state-funded, programme of Austro-Hungarian railway construction. Between 1875 and the early 1890s Austria's debt to GDP ratio rose from 55% to almost 80%, while Hungary's ratio soared from 70% to 120%. By comparison with the euro area's Stability Pact ceilings of 3% for budget deficits and 60% for the debt to GDP ratio, these were big numbers. Contemporary investors did not monitor debt to GDP ratios, a concept that had yet to be invented, but they carefully watched the quantity and quality of government tax revenues as well as levels of spending and public debt. By 1890, Austria and Hungary had reached the limits of their ability to tap international investors, particularly after the sensational Baring crisis of that year focused attention on the lax international lending of the late 1880s and was followed by a sharp downturn in international capital flows in the early 1890s. Recognition that the deficits and borrowings were becoming unsustainable seems to have complemented the concern about currency volatility in the early 1890s, prompting the financial reforms of 1892-1896 that marked the second phase of the development of the Austro-Hungarian monetary union.
The third phase of the Austro-Hungarian monetary union from the mid-1890s to the war, witnessed distinctly more sober public finance ratios. In most of these years the country level budget deficits of both countries were in the 0-5% range. However, at the end of the period, particularly with the annexation of Bosnia-Herzegovina in 1908, military spending mounted resulting in several deficit spikes. These decades also saw long-term declines in both countries' debt to GDP ratios: by 1913 Austria's debt to GDP ratio was down to 60% and Hungary's to 70%, the completion of the major railway building schemes relieving pressure to borrow for that purpose. The instigation of the monetary reform programme demonstrated that the governments had recognised that the fiscal rake's progress of the 1880s could not continue, but the transformation of the Austro-Hungarian Bank from a government factotum into a bold and resolute independent central bank was a distinctly unanticipated outcome.
The formidable monetary authority developed by the Austro-Hungarian Bank in the 1890s and 1900s impressed contemporaries. Writing in 1905, German economist G. F. Knapp, author of The State Theory of Money, proposed that it had moved beyond the concept of commodity money, the notion that strict specie convertibility constitutes the sole basis of the value of paper money which by itself is worthless, and had demonstrated that the value of money could be institution-based. Knapp argued that it was not the reserves but the prestige of the Austro-Hungarian Bank as a legal-bureaucratic entity that ensured the stability of the Austro-Hungarian currency. This, Knapp proposed, made it the pioneer, and prototype, of a modern central bank.
The Austro-Hungarian Bank was assisted in its endeavours to ensure monetary good-housekeeping by the financial markets. The high levels of borrowing and currency volatility of the 1880s led investors in Austrian and Hungarian bonds, particularly foreign investors, to require higher yields as compensation for what they perceived to be higher default and exchange rate risks, meaning higher borrowing costs for the governments. To borrow more cheaply, the bonds of governments of inferior creditworthiness might feature a 'gold clause' which provided for loan servicing in sterling or another trusted gold standard currency. This transferred exchange rate risk from the lender to the borrower. Austria first introduced a gold clause in 1876, with Hungary following a few years later. The proportion of outstanding debt to be serviced on a gold basis steadily increased: over the years 1880 to 1895, for Austria from 11% to 19%; and for Hungary from 25% to 32%. Once again, this made the governments concerned about exchange rate volatility, which made debt payments unpredictable, and about currency depreciation which increased their external debt burden.
Adoption of the gold standard or, as actually happened, adherence to an exchange rate peg, protected governments from the exchange rate risk deriving from their gold clause external borrowings. But for this to be effective required two things: a credible central bank with control over monetary matters; and responsible country level budgets and borrowing. In the euro area the latter are requirements of the Stability Pact; in the Austro-Hungarian monetary union, in the absence of a Stability Pact, it was the markets and the central bank that obliged the governments to restrain deficits and debts.
The Austro-Hungarian monetary union's notable monetary achievements were matched by a decidedly mixed macroeconomic performance. Over the period 1870-1913, Austria's annual per capita growth rate averaged just 1.05%, similar to that of Britain and Belgium, mature economies which in 1870 already had per capita incomes around twice that of Austria, and were near the bottom of the European league table for economic growth in those decades. Austria's average rate was depressed by its disastrous performance in the two decades following the 1873 Vienna crash which saw average annual per capita income growth of a dismal 0.71%; but for the period 1895-1913, the years of the shadow gold standard, the average per capita growth rate was double, a respectable 1.49%, similar to France and Sweden, though well short of Germany's 1.63%. Doubtless many factors contributed to this improvement; greater monetary stability may well have been one of them.
Austria-Hungary's ultimatum to Serbia on 23 July 1914, the opening move towards war, provoked panic on the Vienna and Budapest stock exchanges and runs on central European banks. Such was the political and financial mayhem that it was not until 4 August 1914, a week after Austro-Hungary's actual declaration of war, and the day Britain joined the conflict, that the Austro-Hungarian government suspended gold convertibility of the crown and the requirement for the Austro-Hungarian Bank to hold 40% gold cover for the note issue, as well as instructing it to ignore its prohibition on lending to the state. Indeed, the Austro-Hungarian war effort was largely financed by printing money to meet government requirements, with the once proud and independent Austro-Hungarian Bank acting as the government's 'abject agent'. Rampant inflation resulted; between July 1914 and the Austro-Hungarian Armistice in October 1918, the Bank's stock of currency increased by 1,340% (while its gold reserves fell by 80%).
Defeated, the dual monarchy fell apart in autumn 1918. Out of the ruins there emerged five new or modified 'successor states': Czechoslovakia, Romania, Yugoslavia, Austria and Hungary. The unwinding of Austria-Hungary's monetary arrangements had several distinct dimensions: the separation of outstanding Austro-Hungarian crown notes into national holdings; creation of successor state currencies; the establishment of successor state central banks; the liquidation of the Austro-Hungarian Bank; and the stabilisation of the successor state currencies.
Currency separation and the creation of the successor state currencies proceeded in two stages: the stamping of Austro-Hungarian crown notes; and the exchange of stamped crown notes into national currencies. The peace treaties specified that the successor states should stamp Austro-Hungarian Bank notes circulating in their areas and then introduce their own notes within a year. In February 1919 there were in total 37.6 billion paper Austro-Hungarian crowns in circulation, but the claims of successor states as to circulation in their territories added up to 44.9 billion. This mattered because the volume affected successor state claims on the reserves and other assets of the Austro-Hungarian Bank. Eventually to simplify and expedite matters the separation of pre-Armistice crowns among the successor states was determined by negotiation, taking account of populations and stamped banknotes, with the resulting total somehow summing to a streamlined 29.1 billion crowns.
During 1919 and early 1920, in distinctly uncoordinated succession, Yugoslavia, Czechoslovakia, Austria, Romania and Hungary, stamped the Austro-Hungarian Bank banknotes in circulation in their territories with a national emblem, thereby converting the crown notes into national currencies. The process was complicated by the successor states imposing varying conversion taxes or forced loans on the stamped notes - 50% in cases of Czechoslovakia and Hungary. There was widespread avoidance of the levies by the forgery of national stamps. Moreover, many holders initially withheld notes from stamping seeking the most favourable terms, resulting in substantial illicit cross-border flows of unstamped crown notes. A further complication in some successor states was substantial circulations of other paper currencies. Czechoslovakia led the way in the exchange of stamped Austro-Hungarian Bank banknotes into the national currency in 1919. Yugoslavia and Romania undertook currency exchanges in 1920. Austria and Hungary initially persevered with stamped Austro-Hungarian crowns, but subsequently introduced new currencies. Thus ended the Austro-Hungarian monetary union's common currency.
A liquidator for the Austro-Hungarian Bank was appointed in August 1920. The peace treaties provided that stamped notes should be returned to the liquidator for accounting and destruction. In practice this was less than straightforward; for instance, the 2.7 billion worth of Austro-Hungarian crown notes returned from Poland occupied 2,917 packing-crates. According to the treaties, pre-Armistice notes represented claims against the assets of the Austro-Hungarian Bank, notably its gold reserves, 175 million crowns, and property, 25 million crowns. The assets were distributed among the successor states (and Italy and Poland, too) in accordance with the negotiated distribution pattern of pre-Armistice crowns, though modified by various considerations. The completion of the liquidation in July 1924 marked the end of the Austro-Hungarian Bank.
The epilogue to the demise of the Austro-Hungarian monetary union was the stabilisation of successor state currencies. Czechoslovakia, which comprised the most economically developed regions of the dual monarchy, led the way. As related, 1919 saw the prompt introduction of Czechoslovak crown banknotes and the creation of a Czechoslovak proto-central bank. The latter's prohibition from lending to the government immediately stabilised the new currency; markets recognised that the driving force behind monetary expansion had been removed. Austria and Hungary, defeated and impoverished, faced much greater challenges including huge deficits and hyperinflation. International reconstruction loans were needed for them to stabilise their currencies in the early-mid 1920s.
What lessons might be drawn for the eurozone from the experience of the Austro-Hungarian monetary union? The exercise is complicated by the fact that while there are some notable structural and evolutionary parallels, EMU to a large extent is sui generis.
The Austro-Hungarian monetary union's successful operation for almost half a century demonstrates that an 'single currency, separate governments' monetary union such as the eurozone is not necessarily unstable or a staging post to a political union. The structural parallels, identified at the beginning of the paper, are a single currency and independent central bank, in conjunction with sovereign states with their own finance ministries.
The evolution of the monetary arrangements of the Austro-Hungarian monetary union in a series of stages appears to have parallels with the development of EMU. In the Austro-Hungarian case, the stages were: (i) fiscal and debt indiscipline; (ii) reform and retrenchment; (iii) fiscal and debt discipline, with strong leadership from the independent Austro-Hungarian Bank. In the case of the eurozone: (i) the relatively undisciplined Exchange Rate Mechanism stage; (ii) the Maastricht criteria convergence process that preceded the introduction of the euro; (iii) the euro era, with the European Central Bank playing a prominent and powerful role.
The leadership roles of the Austro-Hungarian Bank and the European Central Bank appear to have strong resonances, as do their respective run-ins with politicians demanding more control or modified priorities. The leadership of the Austro-Hungarian Bank was a key factor in the success and longevity of the Austro-Hungarian monetary union. Other factors were a set of monetary and fiscal rules, commitment to abidance by the rules on the part of the participant governments, and the geographic stability of Austria-Hungary.
While Austria and Hungary were both constrained by the expectations of the financial markets, eurozone members have been more formally disciplined by the dictates of the Stability and Growth Pact. This is a distinct difference between arrangements, though the Austro-Hungarian experience demonstrates that behind the formal requirements of the SGP lies a second line of defence for monetary stability - the market - as some southern members of the eurozone have recently been reminded.
But, almost from the beginning, the SGP - the eurozone's answer to the problem of credibility - was undermined. Furthermore, breaches of the SGP were pioneered not by Club Med but by France and Germany which ran excessive deficits in the early 2000s. Little wonder, perhaps, that other euro area countries felt free to play fast and loose with the SGP rules. This was in contrast to the fiscal sobriety of Austria and Hungary in the early twentieth century. By the time of the sovereign debt crisis, the SGP had already demonstrated its effectiveness in the face of determined resistance (covert or overt) by governments.
Doubtless it is easier to monitor and manage a monetary union of two countries than a group of 17. A fundamental dynamic of the eurozone that differentiates it from the Austro-Hungarian monetary union is that it has an enlargement agenda with the ultimate ambition of embracing all European Union countries. But its expansionary goal has collided with its cohesion as a monetary union. In contrast, the Austro-Hungarian monetary union's geographic stability and political coherence enhanced its financial stability. With an undermined SGP and a set of disparate member states, the alternatives for the eurozone would appear to be a reversal of its expansionary agenda and a retreat into a smaller and more coherent optimum currency area - à la Austria-Hungary - or a fiscal (and political) deepening, meaning a single Eurozone finance ministry and taxes.
Finally, the demise of the Austro-Hungarian monetary union was not the result of its own shortcomings, but of an apocalypse that not only devastated its monetary operations but laid waste the world in which it existed. Doubtless the euro area would also succumb to a shock of such magnitude.
Berend, I.T. and G. Ranki, Economic Development in East-Central Europe in the 19th and 20th Centuries, (New York: Columbia University Press, 1974)
Garber, Peter M. and Michael G. Spencer, The Dissolution of the Austro-Hungarian Empire: Lessons for Currency Reform, IMF Working Paper no.92/66 (Washington D.C.: IMF, 1992) Edie, Scott, economic policy and economic development in Austria-Hungary 1867-1914. Cambridge Economic History of Europe, vol. VIII (Cambridge: Cambridge University Press, 1989).
Flandreau, Marc, The Bank, the States, and the Market: An Austro-Hungarian Tale for the euro area, 1867-1914, Österreichische Nationalbank Working Paper 43 (2001) Komlos, John, Diffusion of financial technology into the Austro-Hungarian monarchy toward the end of the nineteenth century, in Komlos, John (ed), Economic Development in the Habsburg Monarchy in the Nineteenth Century (New York: Columbia University Press, 1983)
Kover, György, The Austro-Hungarian Banking System, in Cameron, R. And Bovykin (eds), International Banking 1870-1914 (1991) pp. 319-44Marz, Eduard, Austrian Banking and Financial Policy (London: Weidenfeld and Nicolson, 1984)
Rudolph, Richard L., Banking and Industrialisation in Austria-Hungary (NY: CUP, 1976)
Sign up to receive announcements on events, the latest research and more!
We will never send spam and you can unsubscribe any time.
H&P is based at the Institute of Historical Research, Senate House, University of London.
We are the only project in the UK providing access to an international network of more than 500 historians with a broad range of expertise. H&P offers a range of resources for historians, policy makers and journalists.
