Transcript slides 9 File

9. THE GREAT DEPRESSION AND THE GOLD STANDARD
The interwar period was a prolonged period of political and economic instability.
The gold standard had in the 19th century been seen as an admiral automatic
mechanism for monetary and price stability.
This was not the case for the interwar period. In that period the gold standard
functioned as a mechanism that transmitted the depressive impulse from the US to
the rest of the world.
In fact, the gold standard magnified the original instability, it prevented offsetting
action in all countries on the gold standard, and it acted as a constraint preventing
authorities from containing financial panic and bank failures.
1
The gold standard before and after WWI
All countries (with partial exception for the US) were forced to abandon the gold standard during
WWI. Given the monetary financing of large budget deficits, there was a period of very rapid
inflation during and immediately after the war.
The bilateral exchange rates during the gold standard would be fixed and equal to the ratio of
their gold parities. The basic purpose of the gold standard was that money supply would be
regulated by the balance of payments in such a way as to keep the price level stable at the level
that ensured external balance or trade balance (section 7).
There were also other equilibrating mechanisms at work than the trade balance such as:
- stabilizing capital flows caused by exchange rate expectations
- gold arbitrage
- central banks raising interest rates if need be (to attract capital inflows)
- lending of gold/foreign exchange as between monetary authorities.
This worked fine before WWI: there was a constellation of factors – including the distribution of
power in society, the prevailing economic doctrine and the capacity for international cooperation
– which explains the long-standing stability of the gold standard.
After the war the power of labor had increased, the doctrine was less influential and
international cooperation more or less broke down.
2
What kind of stability during the gold standard?
Table x: Inflation and output growth in the UK and the US
United Kingdom
United States
1870-1913 1946-1979
1870-1913 1946-1979
Rate of inflation
(wholesale prices)
- 0.7
5.6
0.1
2.8
Standard deviation
4.6
6.2
5.4
4.8
Annual growth rate
of GDP per capita
1.4
2.4
1.9
2.1
Coefficient of variation
2.5
1.4
3.5
1.6
3
What kind of stability during the gold standard?
Table: Levels of wholesale prices in selected countries 1816-1913 (1913=100)
United States United Kingdom Germany France
1816
150
147
94
143
1849
82
86
67
94
1873
137
130
114
122
1896
64
72
69
69
1913
100
100
100
100
4
The Great Depression
In mid 1920s most European countries went back to the gold standard (which the US
had largely remained on during the war). However, the political changes served to
undermine the credibility of the gold standard regime. In the new circumstances it
was not clear that exchange rate deviations from parity would induce the kind of
stabilizing capital flows that had taken place before the war.
Also, given higher unionization rates and increased political power of parties associate
with labor, it was less clear that wages would adjust flexibly to correct trade balances.
In many countries economic policy issues and notably fiscal policy became the subject
of intense political conflict.
Finally, there was not the same readiness to international cooperation between
governments and central banks with a view to deal with payment difficulties.
5
The Great Depression (cont.)
•
Originated in the US (’Black Thursday on 29 October 1929, cause or symptom?)
•
Continued for many years, notably in the US until WWII
•
Its causes are still to some extent a matter of debate, but tight or passive
monetary policy in the US is a key aspect
•
Was transmitted world wide through the mechanisms of the gold standard
•
Aspects (cf. Figures): the stock market, production, employment, farm prics, debt
deflation
6
Figure 1: the US stock market
7
Fig 2:US annual GDP from 1910 to 1960, volume
8
Fig.3: Unemployment in the USA
9
Fig. 4: Soup kitchen in Chicago in 1931 (opened by Al Capone)
10
Fig. 5: US Farm Prices during the Great Depression
11
Fig. 6: The deflationary process
12
Deflation and depression raised the debt ratio
13
Fig. 6: Deflation causes bank failues
14
Great Depression: developments in Europe
•
Developments in Europe were similar but less severe (developing countries were also
seriously affected by falling commodity prices and the fall in capital imports)
•
Output levels and GDP per capita declined + undemplyoment increased + large-scale
banking panics (notably in Austria and Germany) and wide-spread bank failures,
introduction of foreign exchange controls de facto suspending convertibility into gold.
•
Britain was forced to leave the gold standard early, in 1931, and was soon followed by a
number of countries (including Finland), which then pegged their currencies to Britain,
their most important trading partner.
•
It is a remarkable testimony to the role of the gold standard that those countries
recovered first that left the gold standard earliest (table and fig). The gold standard
functioned as a straightjacket preventing action to combat the crisis and to avert the
bank failures.
15
Table: GDP per capita (PPP) 1929-1939
USA
WEU
GBR
GER
FRA
FIN
1929
100
100
100
100
100
100
1930
90
98
99
98
96
98
1931
82
92
93
90
90
95
1932
71
89
94
83
84
94
1933
69
92
96
88
90
99
1934
74
95
102
95
89
110
1935
79
97
105
102
87
114
1936
90
99
110
110
90
121
1937
93
104
113
116
95
126
1938
89
106
114
123
95
132
1939
95
111
114
133
102
125
16
Real income per capita in the interwar period
17
GDP developments in selected countries
18
Japan was never on the gold standard, Britain (and a number of other
countries including Finland) left gold in 1931, Germany and the US later and
France held out the longest
19
Legacy of the Depression
20
The role of economic policies
It is still an issue for debate whether the Great Depression should be seen as a failure of free
markets or of mistakes made by authorities, notably central bankers. The decline in money supply
in the US (fig) has been much emphasized (Milton Friedman and Anna Schwartz); it is partly
endogenous but could have been prevented by a more active monetary policy by the US Fed.
Nominal interest were low, but real interest rates (presumably also expected real interest rates)
were extremely high.
The Fed, to a large extent, took a position close to ‘liquidationism’.
Public debt in the US increased as a share of GDP in the early phase of the depression, but this
was due more to the decline in GDP than to any expansionary action. President Franklin D.
Roosevelt later tried, inter alia, public works and farm subsidies, but these actions were too
cautious to have any significant economic effects. He never gave up the ambition that the federal
budget should balance and public debt remained at a low and rather stable level relative to GDP.
Passive economic policies did little if anything to try to stop the depression. This was due to the
constraints on policies imposed by the gold standard but also because the established doctrine
suggested that there was no useful role for active policies.
21
Development of narrow money supply in the US in 1926-40
22
Broad money supply in the US
23
US interest rates were low in nominal terms in the 1930s,
but they were extremely high in real terms
24
UK inflation was negative (real interest high) during many years
25
US public debt increased but mainly as a consequence of the depression
rather than as a consequence of expansionary fiscal policy
26
WPA employed 2-3 million workers
27
Central banks almost always hate inflation
28