Exchange Rates and Economic Recovery in the 1930s

The Journal of Economic History

Volumn 45, Issue 4, 1985, Pages 925-946

  Eichengreen, Barry ^a   Sachs, Jeffrey ^a  

^a HARVARD UNIVERSITY   (United States)

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EID: 84974080768     PISSN: 00220507     EISSN: 14716372     Source Type: Journal    
DOI: 10.1017/S0022050700035178     Document Type: Article

References (49)

1. The classic indictment of the Fed is of course Milton Friedman and Anna Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, 1963).
2. For analyses which emphasize also the effects of protectionist initiatives, see Alan Meltzer, “Monetary and Other Explanations for the Start of the Great Depression,” Journal of Monetary Economics, 2 (1976), pp. 455–72;
3. and Christian Saint-Etienne, The Great Depression, 1929–1938: Lessons for the 1980s (Stanford, 1984).
4. Charles P. Kindleberger, The World in Depression, 1929–39 (Berkeley, 1973);
5. Karl Hardach, The Political Economy of Germany in the Twentieth Century (Berkeley, 1976);
6. and A. Sauvy, Histoire économique de la France entre les deux guerres (2nd ed., Paris, 1984).
7. This is not to imply that the Great Depression in Europe was solely a reflection of the downturn in the United States. (On Europe's difficulties in the 1920s, see Ingmar Svennilson, Growth and Stagnation of the European Economy (Geneva, 1954);
8. or Peter Temin, “The Beginning of the Depression in Germany,” Economic History Review, 2nd ser., 24 (1971), pp. 240–48.) All that is necessary for the argument is that the Depression in Europe was heavily affected by concurrent developments in America. Space limitations do not permit us to formally address the causes of the Depression.
9. For a statement of this view, see Ragnar Nurkse, International Currency Experience (Geneva, 1944).
10. Even these cases have been disputed. Lars Jonung, “The Depression in Sweden and the United States: A Comparison of Causes and Policies,” in Karl Brunner, ed., The Great Depression Revisited (Boston, 1981), pp. 286–315, has questioned the role of fiscal policy in Swedish growth.
11. M. Beenstock, F. Capie, and B. Griffiths, “Economic Recovery in the United Kingdom in the 1930s,” Bank of England Panel of Academic Consultants, Discussion Paper (London, 1984), have attempted to show that policy had little role in Britain's recovery. The German situation is in many ways special and will be given relatively little attention here.
12. An extensive literature analyzes the extent to which public officials, especially in Britain, were or were not converted to Keynesian views in the 1930s. See for example Susan Howson and Donald Winch, The Economic Advisory Council, 1930–1939 (Cambridge, 1977);
13. G. C. Peden, “Keynes, the Treasury and Unemployment in the Later Nineteen-thirties,” Oxford Economic Papers, n.s., 32 (1980), pp. 1–18;
14. and Alan Booth, “The ‘Keynesian Revolution’ in Economic Policy-Making,” Economic History Review, 2nd ser., 26 (1983), pp. 103–23.
15. See Harry G. Johnson, “Optimum Tariffs and Retaliation,” Review of Economic Studies, 21, no. 2 (1953/54), no. 55, for one of the original game-theoretic analyses of tariff wars. Johnson shows that all countries suffer from a tariff war with retaliation if their economies are symmetric, while some countries may be better off, relative to free trade, in an asymmetric environment.
16. In this respect, our work supports the findings of E. Choudri and L. Kochin, “The Exchange Rate and the International Transmission of Business Cycle Disturbances,” Journal of Money, Credit and Banking, 12, no. 4 (1980), pp. 565–74.
17. Choudri and Kochin document the relationship between exchange depreciation and relative national price levels and outputs for several European countries. An analysis almost identical to theirs appears in George F. Warren and Frank A. Pearson, Prices (New York, 1933). Neither set of authors, however, works with a formal macroeconomic model, as in this paper, and thus they do not attempt to describe the structural mechanisms linking exchange rates with other aggregate variables. Neither do they discuss the foreign repercussions of exchange rate changes. The conclusion that the currency depreciation in the 1930s benefited the initiating country is itself controversial, since it has recently been argued, in the spirit of the new classical macroeconomics, that the effects of depreciation were in some instances negligible. Beenstock, Capie and Griffiths, “Economic Recovery,” passim. The new classical macroeconomics insists that purely monetary changes, such as changes in the price of gold, can have no real effects since other nominal values will adjust proportionately to the monetary change. We argue that the experience of the 1930s is clearly inconsistent with this doctrine.
18. The phrase is from Nurkse, International Currency Experience. We elaborate on its meaning below.
19. U.S. foreign lending began to contract in 1928 as the New York stock exchange boom drove up interest rates and diverted funds from foreign lending to domestic financial markets, and this contraction accelerated as the Federal Reserve failed to accommodate the rising demand for credit. The decline in primary commodity prices following the downturn in the United States was not an entirely new development, as commodity prices had been trending downwards for much of the decade owing to the vast expansion in non-European productive capacity that had taken place during World War I. See Svennilson, Growth. The same can be said of the move toward protection, which was well underway before the onset of the Depression.
20. See for example H. Liepman, Tariff Levels and the Economic Unity of Europe (London, 1938);
21. or J. B. Condliffe, The Reconstruction of World Trade (New York, 1940).
22. The Austrians followed the Germans with a lag, imposing exchange control in October 1931. Britain's devaluation has been examined recently by Alec Cairncross and Barry Eichengreen, Sterling in Decline: The Devaluations of 1931, 1949 and 1967 (Oxford, 1983).
23. There is some dispute over the importance of financial difficulties such as the Continental bank failures relative to the development of Britain's balance of payments position. See also Donald Moggridge, “The 1931 Financial Crisis—A New View,” The Banker (1970), pp. 832–39.
24. By December 1931, when sterling reached a trough, it had depreciated by 40 percent relative to the currencies which remained on gold. This raises the question of how countries which did not engage in depreciation could ignore such a large relative price effect. The answer is that they concluded almost universally that the costs of a loss of competitiveness were more than outweighed by the benefits of avoiding the inflation that devaluation might provoke. This was clearly the basis for the French decision: see Marguerite Perrot, La Monnaie et l'opinion publique en France et en Angleterre, 1924–1936 (Paris, 1955).
25. Despite the popularity of competing explanations, Kindleberger, World in Depression, pp. 163–64, concludes that this was the basis for the German decision as well.
26. There is considerable dispute over the extent to which the U.S. administration understood the relationship of its gold-buying program to the exchange rate and the price level. See John Morton Blum, From the Morganthau Diaries, Years of Crisis, 1928–1938 vol. 1: (Boston, 1959), p. 73;
27. or Kindleberger, World in Depression, pp. 226–27.
28. In addition, the deterioration of economic conditions in its colonial possessions further undermined Belgium's budgetary position. Moreover, late in the summer of 1934, the government turned to a reflationary program, lowering the central bank discount rate and expanding credit in an effort to revitalize the economy. These efforts were sufficient to undermine confidence in the currency but inadequate to stimulate recovery. See H. van der Wee and K. Tavernier, La Banque Nationale de Belgique et l'histoire monétaire entre les deux guerres mondiales (Brussels, 1975).
29. These difficulties were least pronounced in Holland, whose trade was heavily concentrated in its seven colonies and hence immune to the effects of foreign tariffs, and whose coal, electricity, and cement industries actually continued to expand between 1929 and 1933. See Fernand Baudhuin, “Europe and the Great Crisis,” in Herman van der Wee, ed., The Great Depression Revisited (The Hague, 1972). The French case bears a remarkable resemblance to that of Belgium. In September 1935, the French government, which had previously remained firm in its commitment to deflation, demanded new constitutional powers to enable it to carry through its program, which were ultimately denied. This government fell and was replaced by another which included a policy of domestic credit expansion as part of its program. See Sauvy, Histoire.
30. These negotiations culminated in the Tripartite Agreement of September 1936. See S.V.O. Clarke, “Exchange-Rate Stabilization in the Mid-1930s: Negotiating the Tripartite Agreement,” Princeton Studies in International Finance, no. 41 (Princeton, 1980);
31. and Barry Eichengreen, “International Policy Coordination in Historical Perspective: A View from the Interwar Years,” in Willem Buiter and Richard Marston, eds., The International Coordination of Economic Policies (Cambridge, 1985) for details.
32. For qualitative evidence see Susan Howson, “Sterling's Managed Float: The Operations of the Exchange Equilisation Account,” Princeton Studies in International Finance, no. 46 (Princeton, 1980);
33. and for econometric support see Cairncross and Eichengreen, Sterling in Decline.
34. See Bank for International Settlements, Annual Report (Basle, 1934), for examples.
35. To keep the percentage of gold backing unchanged, open market operations are required not just to inject into circulation currency in the amount of the capital gains on gold reserves but also to increase the domestic credit component of the monetary base by the proportion of devaluation. Compare Gottfried Haberler, Prosperity and Depression (Geneva, 1937).
36. Belgium's participation in the Gold Bloc and her decision to leave in 1935 are discussed in detail by van der Wee and Tavernier, La Banque. A detailed description of German exchange control is provided by Howard S. Ellis, Exchange Control in Central Europe (Cambridge, 1941).
37. French opinion on monetary and financial questions, along with British comparisons, is reviewed by Perrot, La Monnaie.
38. Political aspects of the French debate are summarized by Sauvy, Histoire économique.
39. The definitive analysis of the decision to return to par in 1925, which highlights the role of the few dissenters such as Keynes, is Donald E. Moggridge, The Return to Gold, 1925 (Cambridge, 1969). An account which emphasizes the implications of the 1925 decision for attitudes toward depreciation in 1931 is Cairncross and Eichengreen, Sterling in Decline.
40. Although both industrial production and the real wage are endogenous variables, we report the regression for completeness. IP1935 = 175.2 − 59.8 (WAGE1935/WPI1935) (7.39) (3.14) [formula omitted] Similar relationships are reported by Sheila Bonnell, “Real Wages and Employment in the Great Depression,” Economic Record (1981), pp. 277–81.
41. Control of the German labor market has been analyzed by Otto Nathan, The Nazi Economic System (Durham, 1944);
42. and, more recently, by Frank Kim, “The German Economy during the Interwar Period: Preparation for War?” (thesis, Harvard College, 1983).
43. See James Tobin, “A General Equilibrium Approach to Monetary Theory,” Journal of Money, Credit and Banking, 1 (1969), pp. 15–29.
44. It is conceivable that this could yield the outcome suggested by Kindleberger, namely that devaluation could lower prices abroad while leaving home-country prices unchanged. Note, however, that the mechanism is very different from his argument concerning a ratchet effect in commodity markets. Kindleberger, World in Depression, chap. 4.
45. For a formal analysis of the effects of commercial policy, see Barry Eichengreen, “A Dynamic Model of Tariffs, Output and Employment Under Flexible Exchange Rates,” Journal of International Economics, 11 (1981), pp. 341–59;
46. Barry Eichengreen, “The Smoot-Hawley Tariff and the Start of the Great Depression” (unpublished manuscript, 1984).
47. To date, constant employment measures of the government budget have been constructed only for the United States and Britain. See E. Cary Brown, “Fiscal Policy in the Thirties: A Reappraisal,” American Economic Review, 46 (1956), pp. 857–79;
48. and Roger Middleton, “The Constant Employment Budget Balance and British Budgetary Policy, 1929–39,” Economic History Review, 2nd ser., 34 (1981), pp. 266–86.
49. For an extension to the analysis of commercial policy, see Barry Eichengreen, “The Australian Recovery of the 1930s in International Comparative Perspective” (unpublished paper presented to the conference on the Australian Economy in the 1930s, Canberra, August 1985, and forthcoming in the conference volume).