Policing the Chain Gang: Panel Cointegration Analysis of the Stability of the Sufforl System, 1825-1858

Conventional monetary theory suggests that a closed system banking regime may lead to a systematic and uniform over-expansion of circulation. However, Selgin (2001, 2010) argues that as the number of banks increases, they act much as a “chain gang” does, making coordination all the more difficult. As long as note redemption occurs rapidly, banks are forced to pay a penalty for holding negative balances with one another, and there is a positive rate of interest charged for loans between banks, then the only possible means for a uniform increase to occur is dependent upon a prior increase in specie. In order to test this conjecture, we employ a battery of cointegration techniques upon a unique dataset compiled from the Suffolk Banking System between 1825-1858. We find evidence to suggest that Selgin’s (2001,2010) conjecture is indeed correct and is robust to a number of specifications, something never before empirically tested or observed within the literature.