Dynamic Macroeconomics

particular trend until World War I, because for most of this period, both the
United States and the United Kingdom had adopted metallic monetary
systems, based on precious metals (specie), such as gold and silver. Such
metallic systems constrained the rate of growth of the money supply. When
they were forced to temporarily abandon such systems, as during wars, both
countries sought to return to such systems as soon as possible.
Britain had been on a de facto gold standard since the early eighteenth
century. The United States had been on a silver standard until 1834, on a
bimetallic standard until 1861, and on an effective gold standard since 1879.
During the Napoleonic Wars of 1803–1815 in the United Kingdom and the
American Civil War of 1861–1865 in the United States, the convertibility to
specie was suspended. Thus, the link of the money supply to gold and silver
was relaxed through the issuance of nonconvertible paper currency. The Bank
of England issued nonconvertible sterling banknotes, and the United States
issued nonconvertible greenbacks. The issuance of nonconvertible banknotes
was used to finance these countries’ respective war and resulted in large
increases in the money supply. The increase in the money supply resulted in a
rise in the price level through inflation. Yet in both countries, the suspension
of convertibility was always considered to be temporary. Sterling
convertibility was restored in 1821, and dollar convertibility was finally
restored in 1879.
What happened during the Napoleonic Wars and the American Civil War
is an example of the use of seigniorage (i.e., revenue from money creation)
to partly finance temporary increases in government expenditure.
Government expenditure rises significantly during a war, and money creation
is one of the ways to finance this temporarily increased expenditure. The
other is government debt.
Figure 1.14
 depicts the federal debt of the US government as a percentage
of GDP since 1792. With a few exceptions, episodes of significant increase
in the ratio of federal debt to GDP are associated with recessions and major
wars, such as the American Civil War and the two great wars of the twentieth
century (during 1914–1918 and 1939–1945). Major recessions, such as the

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Great Depression of the early 1930s and the Great Recession of 2008–2009,
are also associated with significant hikes in government debt.