Paper money but a gold debt: Italy on the gold standard

For most of the classical gold standard era, Italy was not formally committed to gold, instead the lira “shadowed” gold. The remarkable stability of the lira exchange rate raises the question of why Italy did not move to official convertibility when it could have gained gold standard benefits at a seemingly low cost. The answer to this puzzle lies in the management of the Italy’s large foreign debt. Although denominated in lire, holders of the debt had the privilege of converting their coupons into gold at the official exchange rate in Paris. This arrangement offered the government an opportunity to temporarily exploit domestic bondholders who found it difficult to circumvent the barriers to arbitrage. In times of fiscal problems, the government gained some seignorage while the lira was allowed a limited depreciation. Shadowing the official gold rate, lost some of the possible benefits of convertibility but gave the government fiscal flexibility.