Policing the chain gang: Panel cointegration analysis of the stability of the Suffolk System, 1825–1858

• Examine the Suffolk System from antebellum New England.
• Evidence that stat-level note issues are cointegrated with Suffolk’s reserves.
• Half-life of deviations from long-run relationship estimated at about 2 years.
• Evidence suggests that the Suffolk checked in-concert overexpansions by banks.
• This conclusion is also supported by narrative accounts of 1837 panic.

Conventional monetary theory suggests that a closed system banking regime may lead to in-concert overexpansions of circulation by its banks. However, Selgin, 2001 and Selgin, 2010 argues that this is unlikely as long as there are enough banks to ensure (i) routine interbank settlement and (ii) no collusion amongst banks refraining from redeeming one another’s notes. Banks effectively form a “chain gang” where in-concert expansion requires coordination that is prohibitively costly in a system with many banks. In order to test this conjecture, we examine state-level data on circulations and reserves from the Suffolk Banking System (1825–1858) in New England. In addition to narrative evidence on the stability of the Suffolk, panel cointegration tests provide evidence of a long-run relationship between state-level circulations and total reserves. The estimated error-correction mechanisms suggest a deviation half-life of about 2 years. We argue that a cointegrating relationship between circulations and reserves, along with rapid error-correction, supports the Selgin hypothesis.