Oye – III Money and finance in the
1930s and 1980s
© Randall W. Stone, 2002
Flexible exchange rates
Pfc=$
S
Exch.
rate
D
Q
Inflation
Curr Acct
Def
Dfc
Imp 
Curr Acct
balance
Devaluation
Exp 
© Randall W. Stone, 2002
Fixed exchange rates
Pfc=$
(fixed)
Exch.
rate
D
Q
Decline in reserves
Inflation
Dfc
Imp 
Real
appreciation
Exp 
Curr Acct
deficit
Reserves
Decline
© Randall W. Stone, 2002
Norms of the gold standard
Deficit countries
Primary
Norms:
Surplus countries
•Defend parity
•Deflate - ↑ int. rates
- ↓ govt. spending
•Ship gold
Secondary Do not privatize:
Norms:
•Extend credits
•Hold foreign
reserves
•Don’t sterilize
gold inflows
- Exchange controls
- Loans
- Sliding tariffs
Simmons 1994
© Randall W. Stone, 2002
International lending in the 1930’s
loans
US surplus
German WWI
reparations
UK, France
Collapse:
WWI debts
• Run on the Austrian Schilling, 1931
• Run on the German RM 1931 > default, cancellation
of reparations
Discrimination:
• UK - Sterling bloc: loans, markets, debts
• Germany - service British banks
- not US banks, bonds
© Randall W. Stone, 2002
Breakdown and reestablishment
Breakdown
• UK 1931
• US 1933
• France 1936
© Randall W. Stone, 2002
Breakdown and reestablishment
Reestablishment
• Tripartite Agreement 1936, further French
devaluation
• Explanation: interests changed
– costs of unilateral cooperation declined
– US, UK preferred France’s devaluation to
commercial discrimination
– reserve holdings liquidated
© Randall W. Stone, 2002
Objections
• Circular
– Infer interests from behavior
– Explain behavior in terms of interests
• Was there cooperation, harmony or
mutual defection after 1936?
© Randall W. Stone, 2002
1982 Debt Crisis--Origins
• Rapid expansion of sovereign lending in the 1970s
• Reaganomics
– U.S. budget deficit → inflation, strong $
– High U.S. interest rates → strong $ → high ratio of debt
service/net exports
• 1979 oil price shock
• Overcommited capital in money-center banks; no
incentives for regional banks to lend
• Expectations shift → credit dries up → default
Contagion effect
© Randall W. Stone, 2002
Managing the 1982 Debt Crisis
IMF, IBRD,
FED
Banks
Borrowers
• 1985 Baker plan (private, IBRD, IMF); little
private lending forthcoming
• 1989 Brady plan
• Conclusion: privatization is necessary
© Randall W. Stone, 2002
Objections
• Subsequent evidence: Resumption of
portfolio investment in 1990s after successful
domestic adjustment
• Theoretical: the debt issue area is
fundamentally different from trade
– There is a basic commitment problem
– Lending will dry up unless the commitment
problem is resolved
© Randall W. Stone, 2002
Macroeconomic coordination
• Spillovers are public
• 1978 Bonn Summit: any effects?
– FRG delays a fiscal expansion
• 1981-1985 Reagan’s non-contingent strategy
– Contraction 1981-1982
– Expansion after 1982
• 1985 Plaza Accord to weaken the dollar
– Japan refuses expansionary fiscal policy
– Dollar declines because Fed lowers interest rates
© Randall W. Stone, 2002