The Slide to Protectionism in the Great Depression Who

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872 Eichengreen and Irwin, What accounts for the cross country variation in the use of protectionist. measures We argue the exchange rate regime and associated economic. policies were key determinants of trade policies in the early 1930s. Countries that remained on the gold standard keeping their currencies. fixed were more likely to restrict foreign trade With other countries. devaluing and gaining competitiveness at their expense they resorted to. protectionist policies to strengthen the balance of payments and limit gold. losses Lacking other instruments with which to address the deepening. slump particularly an independent monetary policy they used trade. restrictions to shift demand toward domestic goods and they hoped stem. the decline in output, In contrast countries that abandoned the gold standard allowing their. currencies to depreciate saw their balances of payments strengthen and. benefited from gold inflows Abandoning the gold standard also freed up. monetary policy so that with no gold parity to defend interest rates could. be cut No longer constrained by the gold standard central banks also had. more freedom to act as lenders of last resort Because they possessed other. policy instruments with which to ameliorate the Depression they were not. forced to resort to trade protection as a second best macroeconomic tool. These findings are obviously related to the literature linking the gold. standard to the Great Depression 3 This research associates the length and. depth of a country s economic downturn and the timing and vigor of its. recovery to how long it remained on gold Countries abandoning the gold. standard relatively early experienced relatively mild recessions and early. recoveries In contrast countries remaining on the gold standard. experienced prolonged slumps Countries leaving the gold standard were. able to relax monetary policy whereas countries staying on gold were. forced to maintain tight monetary policies that inhibited recovery. We offer a trade policy corollary to this thesis countries remaining on. the gold standard and thereby prevented from using monetary policy to. stimulate their economies were more inclined to restrict trade The. stubbornness with which countries clung to the gold standard is thus part. of the explanation for why the world trading system was felled by an. outbreak of protectionism Had countries been quicker to abandon gold. standard orthodoxy and the restrictive monetary policies associated with. it it would have been easier to avert the restrictive commercial policies. that destroyed the network of world trade Our account thus lends. structure to what otherwise seems to be a haphazard scramble to close. markets in the 1930s, See Choudhri and Kochin Exchange Rate Eichengreen and Sachs Exchange Rates. Temin Lessons Eichengreen Golden Fetters and Bernanke Macroeconomics. Slide to Protectionism in the Great Depression 873. THE GOLD STANDARD AND THE GREAT DEPRESSION, The classical gold standard that existed from about 1870 to 1913. linked most of the world s economies through a system of de facto. pegged exchange rates 4 World War I disrupted this system and all of. the major belligerents except the United States impeded gold exports. and loosened the link between gold and the central bank currency and. credit policies Due to postwar economic and monetary dislocations. the principal belligerents only resumed gold convertibility in the mid to. late 1920s 5 While not all countries returned at their prewar parities the. basics of the prewar international monetary system had been put back in. place by the end of the decade, Unfortunately the interwar gold exchange standard was less robust.
than its prewar predecessor Governments largely resurrected the prewar. pattern of exchange rates despite the fact that relative financial strength. and competitive positions had changed as a result of the war Old. gold parities were restored without lowering price levels to prewar levels. resulting in a lower ratio of the value of gold to nominal transactions The. remaining gold was unevenly distributed with some 60 percent in the. hands of the United States and France, To address the postwar shortage of gold the gold standard was. reconstructed as a gold exchange standard so called because it. provided for expanded use of foreign exchange reserves mainly. sterling and dollars in lieu of gold Yet this heightened the fragility. of the system The willingness of countries to hold foreign exchange. was only as strong as the commitment of the reserve center countries. the United States and Britain to honor their commitments to convert. their liabilities into gold at a fixed price If those commitments. were called into question there might be a scramble out of foreign. exchange putting sharp deflationary pressure on the world economy 6. In addition to allowing the free movement of capital this system facilitated the finance of. trade and promoted its expansion Lopez Cordova and Meissner Exchange Rate Regimes. conclude that perhaps 20 percent of the growth in world trade between 1880 and 1910 was due to. the stability provided by the fixed exchange rate regime under the gold standard Estevadeordal. Frantz and Taylor Rise and Fall reach a similar conclusion and also show that trade barriers. were relatively stable over this period, Austria and Germany restored convertibility in 1923 and 1924 with the end of their. hyperinflations As other countries stabilized they too returned to the gold standard Britain. Belgium and the Netherlands in 1925 Canada Czechoslovakia and Chile in 1926 Denmark. and Italy in 1927 and France in 1928, And the credibility of those commitments was now less than before World War I Whether. central banks would subordinate other objectives to defending their gold parities was called into. question by democratization the rise of trade unions and growing awareness of the problem of. unemployment If they wished to maintain investor confidence central banks could not now. show any inclination to deviate from the gold standard rules. 874 Eichengreen and Irwin, In addition the international cooperation that had helped to support. the prewar system allowing countries in crisis to continue to adhere. to gold parities was more difficult in the aftermath of a war that had. bequeathed ill will war debts and reparations, For all these reasons the interwar gold standard was incapable.
of withstanding the shock of the Great Depression 7 The system. immediately came under strain with the economic slowdown and. recession that began in 1928 29 The trigger for this downturn continues. to be debated but many accounts have highlighted the 1928 decisions. by the Federal Reserve to tighten monetary policy and France to de. jure stabilize the franc at a depreciated rate and to convert holdings of. foreign exchange reserves into gold 8 These policies drained gold. from the rest of the world and required other countries to pursue more. restrictive monetary policies, The options for responding to the deflationary pressure were limited. Any major change in monetary policy was precluded by the gold. standard Expansionary fiscal policy was ruled out by the orthodoxy. that governments should run balanced budgets even in downturns 9. This left three options wage and price deflation to restore external. and internal balance at the current gold parity trade and payments. restrictions to limit spending on imports and reduce gold outflows. or abandoning the gold standard and allowing the exchange rate to. depreciate, Some countries remained on the gold standard in the hope that. sufficient wage and price deflation could restore internal and external. balance But the difficulties of wage deflation were considerable and. the burden of long term debts denominated in nominal terms became. progressively heavier Rising unemployment also had political costs. more than a few governments fell as a result Therefore some countries. banned capital outflows and imposed direct controls on payments. for imports to conserve gold and foreign exchange reserves In. effect they preserved the fa ade of the gold standard their de jure. exchange rates did not change but without the reality freedom to. import and export gold and the statutory link between foreign reserves. and money supplies were abrogated or at best honored in the breach. Other countries chose or were forced to abandon gold convertibility and. Chernyshoff Jacks and Taylor Stuck on Gold find that the classical gold standard. allowed countries to absorb terms of trade shocks well whereas the gold standard reconstructed. after World War I did not, See Hamilton Monetary Factors Eichengreen Golden Fetters and Johnson Gold. For example the British Treasury believed that fiscal policy would be ineffective in dealing. with the slump see Peden Treasury View This view was shared by most policymakers around. Slide to Protectionism in the Great Depression 875. permit their currencies to depreciate By severing the link between. the monetary base and gold reserves they were able to pursue more. expansionary monetary policies, Insofar as the problem was too little gold the first best policy. response would have been a monetary expansion achieved through a. worldwide reduction in gold reserve ratios i e in which countries. simultaneously devalued against gold leaving bilateral exchange rates. unchanged 10 In effect this is what had happened by 1936 but without. the international coordination One country after another allowed its. gold reserve ratio to fall equivalently one country after another raised. the domestic currency price of gold Although the prior constellation of. bilateral exchange rates was largely restored at the end of the process. the constraints on monetary policy had been relaxed relative to the. counterfactual in which the original gold standard rules remained in. But the haphazard manner in which this came about had enormous. implications The unilateral way in which one group of countries left. the gold standard created difficulties for those remaining on gold It put. pressure on those left behind to limit gold exports by raising interest. rates restricting imports or regulating foreign exchange transactions. In essence the difficulties facing the international monetary system. created spillover problems for commercial policy,THE TRADE POLICY REACTION.
The movement toward more restrictive trade policies first became. evident immediately following the 1929 business cycle peak The. United States imposed the Smoot Hawley tariff in June 1930 raising. the average tariff on dutiable imports by nearly 20 percent 11 The. increase in American tariffs was deeply resented abroad particularly. as the United States was an international creditor and exports to the. U S market were already declining Smoot Hawley provoked retaliatory. responses notably from its largest trading partner Canada as well as. from a handful of European countries 12 Yet Smoot Hawley was not the. There could have been an international agreement to cut interest rates in concert and to. reduce gold cover ratios But such agreement was impossible to reach given different countries. different histories which rendered them more or less willing to contemplate modification of. their gold standard statutes and their different diagnoses of the nature of the problem see. Eichengreen and Uzan 1933 World Economic Conference. Despite this timing the Smoot Hawley tariff was not a direct response to the Depression. because the basic structure of the tariff rates was set by the House Ways and Means Committee. in early 1929 well before the business cycle peak For an overview of the legislation and its. consequences see Irwin Peddling Protectionism, MacDonald O Brien and Callahan Trade Wars focus on Canada s response. 876 Eichengreen and Irwin, main trigger for the wave of protectionist measures that began in. mid 1931 In comparison to what was to come relatively few countries. raised their tariffs in late 1930 and early 1931 13. The spark that really caused the world trading system to collapse. was the financial crisis in the summer of 1931 The failure of the largest. Austrian bank the Creditanstalt unsettled financial markets and caused. capital flows to seize up The German government depended on foreign. loans to finance its expenditures and the drying up of those loans. triggered a run on the mark 14 To stop the rapid loss of gold and foreign. exchange reserves the government was forced to impose strict controls. on foreign exchange transactions affecting both capital movements and. the finance of trade In theory Germany could have devalued but the. reparations agreement fixed its obligation in dollars of constant gold. content This meant that devaluing would have had devastating effects on. the public finances In any case memories of hyperinflation when the gold. standard was in abeyance meant that abandoning the system would have. unleashed fears of monetary chaos 15 Hungary s financial system also. came under pressure but its banking system was closely tied to Austria s. it imposed controls in July 1931 Other countries such as Chile which was. battered by declining copper prices followed with controls of their own. In August the pressure spread to Britain as trade credits extended to. Germany by British merchant banks were frozen 16 A sharp increase in. exchange rate policies help explain changes in trade policy he Great Depression of the 1930s was marked by a severe outbreak of protectionist trade policies Governments around the world imposed tariffs import quotas and exchange controls to restrict spending on foreign goods These trade barriers contributed to a sharp

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