Business Cycle Economics: Understanding Recessions and Depressions From Boom to Bust by Knoop Todd A

Author:Knoop, Todd A.
Language: eng
Format: epub
Publisher: ABC-CLIO
Published: 2015-10-15T00:00:00+00:00

THE GOLD STANDARD AFTER WORLD WAR I

Most countries dropped off the gold standard during World War I because of the constraints it imposed on monetary and fiscal policies—constraints that were superseded by the need to finance war efforts. However, most of the major economies reinstated the gold standard between 1925 and 1929. The main rationale for returning to the gold standard was a simple one: Policy makers at the time had not thought through any feasible alternatives. Until that point in history, countries had backed their currencies with gold and had maintained fixed exchange rates in order to facilitate international trade. The times when countries were not on the gold standard (primarily when they were engaged in war) were also periods when almost all international trade came to a halt. Most policy makers had not even considered a peacetime option to the gold standard and assumed that abandoning the gold standard meant contracting international trade.

Temin (1989) asserts that the gold standard system that was reconstituted after World War I had four principal characteristics.

Countries fixed their currencies to gold and, as a result, fixed their exchange rates to each other.

Gold movements across countries were unconstrained. Gold flowed into countries with trade surpluses and flowed out of countries with trade deficits.

Asymmetries in the effects of running trade surpluses versus trade deficits were inherent in the system. A country experiencing a trade surplus could accumulate gold reserves without increasing the money supply, which is referred to as sterilization. On the other hand, trade deficit countries were forced to reduce their money supplies as their gold reserves fell in order to avoid devaluation, or reducing its exchange rate. This meant that trade deficits led to deflation and a contraction in economic activity. As a result, countries had significant incentives to bias their economic policies toward hoarding gold through running trade surpluses in order to avoid the negative effects of running trade deficits.

No organization or structure was in place to encourage international economic cooperation, to enforce international agreements, or to provide temporary financing to countries that were short of gold reserves.

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