The very early days of 'model' railway gauges were somewhat confused and I seem to recall that part of the problem was exactly how the gauge was measured. I believe one German manufacturer originally measured their 'gauge' from the rail centre line but used the same rail section (3mm?) in each gauge and this was not clearly understood by others (in UK) trying to produce compatible products. Cannot for the life of me remember where I read this now though..
Anyway, essentially Marklin announced three gauges in 1891 (Spur I, II & III) and this was (obviously) a metric system. In part owing to the confusion about gauge dimensions and (I would also guess) the need for a clear Imperial standard, a committee of the Society of Model Engineers announced five "standard" UK gauges on Feb 1st 1899. As some people get confused by this issue, I'll point out that these were "Gauges" and not "Scales" – although I believe it was generally assumed they referred to standard gauge stock.
For the benefit of any railway modellers here, in 1941 the British Railways Modelling Standards Bureau (BRMSB) was formed, which led to the Model Engineering Trade Association (META) whose members were committed to meet BRMSB 'standards'. Of course different standards popped up elsewhere in the world (the US had their own standards for instance) However, as a lad peering into the window of BEC Models (in Tooting) I do recall wondering what META was/meant…..?
I mention all this as John has generally got things straight but there are these small differences in detail that either get confused (or get skimmed over) in just about everything I read on the subject
So Gauge '2' (for instance) was a 2" gauge which largely died out between the two WW's. Gauge '3' however is built to 2.5" gauge, which to be precise is 63.5mm. In Germany 'Spur II' is very similar to G3 but built to a gauge of 64mm. To be further pernickety – Gauge 3 is built to a scale of 1:22.6 and Spur II to 1:22.5 (same as LGB). As I'm feeling really pernickety, I'll also point out that Gauge 1 is built to 1.75" which is 44.45mm (and not 45mm) However, what is 0.5mm (or 0.55mm) between friends? Well I guess not much but then again you've no idea how much passion gets stoked up over the difference between 10mm and 3/8th in certain circles? 
Anyway, getting back to this thread (Indoor live steam), a certain Mr R Marsh used to bring his coal fired 0-4-0's to the Gauge '3' AGM and run them on his 5 foot diameter (yes – that's 2.5ft radius) test track he that could fold in half and get into his car boot. It used to play havoc with my breathing though (ex-chain smoker I'm afraid) and it would be highly unlikely to be allowed in these days of H&S….
Regards,
IanT