International Economic Policy International
Economic Policy
Problems – Europe in the 1930s
p
Nikolaus Wolf (Warwick and CEPR)
Nikolaus Wolf (Warwick and CEPR)
Timing and extent of a “limp
Timing and extent of a limp recovery
recovery”
• Data on manufacturing output with signs of recovery in 1932
• Recovery was slow, fragmented, and fragile
–
–
–
–
most countries did not reach their 1929 level before 1936
earlier for countries that followed Britain off gold li f
t i th t f ll
d B it i ff ld
very late recovery in Gold‐Bloc, also in the US from about 1936 onwards largely driven by rearmament
o about 936 o a ds a ge y d e by ea a e t
Nikolaus Wolf
International Economic Policy Problems
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19
92801
19
92804
19
92807
19
92810
19
92901
19
92904
19
92907
19
92910
19
93001
19
93004
19
93007
19
93010
19
93101
19
93104
19
93107
19
93110
19
93201
19
93204
19
93207
19
93210
19
93301
19
93304
19
93307
19
93310
19
93401
19
93404
19
93407
19
93410
19
93501
19
93504
19
93507
19
93510
19
93601
19
93604
19
93607
19
93610
160
140
120
AUSTRIA_X11
BELGIUM_X11
100
CANADA_X11
CZ_X11
FIN_X11
80
FR_X11
GERMANY_X11
60
HU_X11
ITALY_X11
POLAND_X11
40
SWEDEN_X11
UK_X11
US_X11
20
0
Nikolaus Wolf
International Economic Policy Problems
3
Timing and extent of a “limp
Timing and extent of a limp recovery
recovery”
• Recovery especially “limp” if seen from post WW2 perspective • Interwar period featured a vast economic potential, which was very poorly exploited due to failed economic policies
Æ What role for policy coordination?
Æ Why did politics react so slow and ill‐coordinated?
Nikolaus Wolf
International Economic Policy Problems
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What role for policy coordination?
What role for policy coordination?
• New technologies with huge potential (electricity, automobiles); required more cross‐border policy coordination than ever
than ever
– Huge potential for remote regions but high capital intensity
– Required Networks (infrastructure, standardisation)
q
(
,
)
• Macroeconomic Policy Trilemma: Policy makers in a small y
y
open economy have to make choices between several desirable objectives that are not all mutually consistent (Obstfeld et al 2004)
Nikolaus Wolf
International Economic Policy Problems
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What role for policy coordination?
What role for policy coordination?
Stable Exchange Rates
Formation
Formation of Trade and Currency
Currency Blocs
Domestic Policyy
Objectives Nikolaus Wolf
C: Modern Solution
International Economic Policy Problems
Free Capital Flows
6
What role for policy coordination?
What role for policy coordination?
• Option A (Gold‐Standard) under pressure after 1918
Option A (Gold Standard) under pressure after 1918
– depended on joint commitment of Central Banks to “rules of the game”, previously orchestrated by the Bank of England – Re‐established System of 1926 significantly less credible • faulty design of 1922, ill‐conceived gold‐parities
• lack of Leadership
lack of Leadership
• Increased power of labour called for domestic objectives
• Alternatives were considered risky
– Adherence to GS seen as “good housekeeping seal of approval” at h
home and abroad (access to capital)
d b d(
i l)
– Adherence to GS seen as commitment to price stability (domestic objective)
j
)
Nikolaus Wolf
International Economic Policy Problems
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What role for policy coordination?
What role for policy coordination?
• Deflationary shocks put European countries between Scylla and Charybdis
– Sticking
Sticking to Option A implied more deflation with rising unemployment to Option A implied more deflation with rising unemployment
and the risk of financial crisis
– Policy response came late and was ill‐coordinated (failure of 1933)
• What prevented a quick and coordinated response?
Nikolaus Wolf
International Economic Policy Problems
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Plan
I
I.
I
Introduction
d i
II The Shadow of World War One
II.
The Shadow of World War One
III The decision (not) to abandon the gold‐exchange standard
III.
The decision (not) to abandon the gold‐exchange standard
IV. The decision (not) to pursue expansionary policies
The decision (not) to pursue expansionary policies
V. The recovery of the 1930s
y
VI. Are there Lessons?
Nikolaus Wolf
International Economic Policy Problems
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The Shadow of World War One
1) Fragile Institutions
• The war had been an “inconclusive test” for hegemonic power in Europe
• New political landscape was more democratic but less stable
– Increased number of sovereign states
I
d
b
f
i
t t
– Governing coalitions far more fragile • This domestic instability undermined both domestic and international policy coordination
Nikolaus Wolf
International Economic Policy Problems
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Nikolaus Wolf
International Economic Policy Problems
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Nikolaus Wolf
International Economic Policy Problems
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Average Cabinet Duration (Years)
Average Cabinet Duration (Years)
Austria‐Hungary
1870 1913
1870‐1913
1923 1939
1923‐1939
2.3
0.9 (Austria)
1.5 (Hungary)
1.5 (Hungary)
Belgium
3.3
1.3
France
1.3
0.6
Germany
1.9
1.4
Italy
1.5
1.4
J
Japan
26
2.6
11
1.1
Netherlands
2.3
2.1
Romania
13
1.3
07
0.7
Sweden
2.7
1.7
United Kingdom
1.7
1.3
Source: Banks (1971)
Nikolaus Wolf
International Economic Policy Problems
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The Shadow of World War One
2) War Debts and Reparations
• WW1
WW1 had produced a web of debt between the Allies and h d
d d
b fd b b
h Alli
d
triggered demand for reparations from Germany (esp. in France, Britain and Italy)
,
y)
• Fatal linkages kept reparations high on the agenda
– France demanded link between reparations and war debts: US
– Reparations Commission linked payments to German “capacity to pay”
– Fifty years anniversary of Versailles did not help
Fifty years anniversary of Versailles did not help
• Affected incentives for policy makers
p y
– Weak incentives for German policymakers to put their house in order
– Hampered international coordination (esp. during summer 1931)
Nikolaus Wolf
International Economic Policy Problems
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The Shadow of World War One
3) The Legacy of Hyperinflation
• Strong inflationary pressures during and after the war
– Britain managed painful return to gold at pre‐war parity – French domestic instability triggered capital flight and depreciation French domestic instability triggered capital flight and depreciation
until summer 1926
• Hyperinflation in Germany, Austria, Hungary, Poland and Russia due to a combination of balance of payment difficulties and distributional conflict over taxes at home
– In Germany mainly driven by conflict over reparations that undermined fiscal stabilisation and confidence in the mark
undermined fiscal stabilisation and confidence in the mark
– In Poland government used control over the Polish mark to finance the war with the USSR; distributional conflict delayed stabilisation
Nikolaus Wolf
International Economic Policy Problems
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Decision (not) to abandon gold
Decision (not) to abandon gold
• The currency crisis of 1931 triggered a first set of effective policy responses to the worldwide depression: several countries abandoned the gold standard
countries abandoned the gold‐standard
• Who left when and why (not)?
Who left when and why (not)?
• Currency crisis models
Currency crisis models
– First generation (fundamentals)
– Second generation (self
Second generation (self‐fulfilling
fulfilling prophecies, contagion)
prophecies, contagion)
– Third generation (moral hazard, regulation, twin crisis)
Nikolaus Wolf
International Economic Policy Problems
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Decision (not) to abandon gold
Decision (not) to abandon gold
• Deflationary shocks 1929‐31 hit vulnerable Europeans
• Austria first, contagion to Hungary
A t i fi t
t i t H
– Creditanstalt‐crisis of May 1931
– difficult negotiations over foreign loan, exchange control Sept 31
difficult negotiations over foreign loan exchange control Sept 31
• Germany in turmoil
y
–
–
–
–
Series of currency and banking crisis had weakened economy
Nazis surge ahead in Sept 1930, close to civil war
June 1931 reparations crisis, Hoover moratorium, French opposition
Twin crisis of early July 1931, failed loan, exchange control 15 July
Nikolaus Wolf
International Economic Policy Problems
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Decision (not) to abandon gold
Decision (not) to abandon gold
• Added to mounting doubts about other weak gold currencies, especially Sterling
–
–
–
–
From mid July 1931 Bank of England lost gold
From
mid July 1931 Bank of England lost gold
July 31 government projected massive deficit and proposed austerity
New “National government” achieved compromise and new loan
g
p
“Invergordon mutiny” triggered financial panic and forced Britain off gold on 20 September 31
• Some followed off‐gold, others not
Nikolaus Wolf
International Economic Policy Problems
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Decision (not) to abandon gold
Decision (not) to abandon gold
Exchange Controls
Exchange Controls
Devaluation
Austria
10/ 1931
09/1931
Belgium
03/ 1935
03/ 1935
Czechoslovakia
09/ 1931
02/ 1934
France
‐
09/ 1936
Germany
07/ 1931
‐
Italy
05/ 1934
10/ 1936
Poland
04/ 1936
04/ 1936
10/ 1936
10/ 1936
Sweden
09/ 1931
09/ 1931
Switzerland
‐
09/ 1936
UK
‐
09/ 1931
United States
03/ 1933
04/ 1933
Source: Bernanke and James (1991), Eichengreen (1992)
Nikolaus Wolf
International Economic Policy Problems
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Decision (not) to abandon gold
Decision (not) to abandon gold
• No country (except US in 1933) left as an act of choice
• Duration models suggest factors that forced off‐gold
–
–
–
–
–
Extent of deflationary shock
O
Occurrence of banking crisis (only debtor countries)
f b ki
i i ( l d bt
ti )
Limited Cushion of gold and foreign exchange reserves
Democratic character of regime (left rather than right)
e oc at c c a acte o eg e ( e t at e t a g t)
Pattern of Trade
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International Economic Policy Problems
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Decision (not) to pursue expansionary policies
Decision (not) to pursue expansionary policies
• The release of the “golden fetters” opened a way for recovery
–
–
–
–
End of deflation and recovery in UK and Scandinavia from 09/1931
/
Reflation and recovery in US from 03/ 1933
Continued deflation and depression in Gold‐bloc
Continued deflation and depression in Gold
bloc
Continued deflation and depression in Germany Nikolaus Wolf
International Economic Policy Problems
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Nikolaus Wolf
International Economic Policy Problems
193610
193607
193604
193601
193510
193507
193504
193501
193410
193407
193404
193401
193310
193307
193304
193301
193210
193207
193204
193201
193110
193107
193104
193101
193010
193007
193004
193001
192910
192907
192904
192901
192810
192807
192804
192801
120
100
80
60
Germany
USA
Sterling
40
Gold
20
0
22
Decision (not) to pursue expansionary policies
Decision (not) to pursue expansionary policies
• Even after summer 1931 general reluctance to pursue expansionary policies
– UK fiscal policy remained neutral (until rearmament in late 30s)
UK fiscal policy remained neutral (until rearmament in late 30s)
– UK monetary policy expansionary from mid‐February 32 onwards
• The ghosts of inflation seen everywhere
– Treasury view in UK remained important
easu y e
U e a ed po ta t
– Sweden, Denmark and Norway reluctant to follow UK monetary expansion (even costly attempts to restore old parities in 1932)
– Dutch poll in June 1936 shows 63% majority against devaluation
– Swiss authorities feared inflation in September 1936 (!)
Nikolaus Wolf
International Economic Policy Problems
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Decision (not) to pursue expansionary policies
Decision (not) to pursue expansionary policies
• Games of Chicken with collateral damage
– Bruening continued his deflationary policies after July 1931, with disastrous collateral damage: unemployment increased Nazi votes
disastrous collateral damage: unemployment increased Nazi votes
– Memory of hyperinflation and legal obligations (Young plan, Hoover moratorium) explain part of this
– Game of Chicken: international conference on reparations under way; wrecking the German economy to convince Allies to end reparations
• Many related cases of strategic delay: – Poland’s adherence to gold to get access to French armament credit g
g
(given rising German threat)
– War debt and ratification of Lausanne delayed by US election Nov 32
Nikolaus Wolf
International Economic Policy Problems
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Decision (not) to pursue expansionary policies
Decision (not) to pursue expansionary policies
• US exit from Gold was very different
– Free choice (large gold reserves, trade surplus)
– Quickly accompanied by expansionary policies Quickly accompanied by expansionary policies
• Deepened European Fragmentation into Currency Blocs
Deepened European Fragmentation into Currency Blocs
– Simultaneously rising trade barriers (in form of tariffs, quotas and exchange controls) to fend off devaluations
– Implemented along pre‐existing fault‐lines
Nikolaus Wolf
International Economic Policy Problems
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“Recovery”
Recovery of the 1930s
of the 1930s
• Was the recovery sustainable? Rearmament took quickly over
– Led by Germany: from at least 1934 fiscal policy focussed on rearmament
– Britain follows in March 1935
• Rhineland‐crisis in March 1936 ends Gold‐Bloc
– Poland leaves Gold in April and launches own armament programme
– Blum government in France delays exit with negotiations over a Tripartite Agreement with the US and Britain
• Thirty Years War rather than Great Depression
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International Economic Policy Problems
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Are there lessons?
Are there lessons? • Models matter
– Policymakers had a “wrong” model; they did not see all options
– Recent crisis highlighted ignorance about financial markets
Recent crisis highlighted ignorance about financial markets
• Politics matters
Politics matters
– Domestic (in)stability, election cycles
– Bilateral tensions, historical perceptions
ate a te s o s, sto ca pe cept o s
• Policies matter
– Coordinated action first best (but unilateral action better than none)
– Leadership and Institutions
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International Economic Policy Problems
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Lessons for the Euro?
Lessons for the Euro?
• Prolonged crisis rather than breakup (
P l
d ii
h h b k (that would be very costly)
• Root: Asymmetries with poor adjustment mechanisms
Root: Asymmetries with poor adjustment mechanisms
– Industry, Finance, Trade: Strong core, weak periphery
– Labour mobility and fiscal transfers limited by politics
• Pressures will grow
– Global actors in financial markets, fragmented regulation
– Growing pressure on budgets (pensions and health care)
• Political will needed to implement rules for fiscal support with clear reform commitment
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