Effective Exchange Rates in Britain, 1920–1930

Abstract

During the 1920s Britain's rate of economic growth lagged behind that of many other countries in the world economy. Much of the historical literature has attempted to explain this outcome in terms of the macroeconomic policy regime resulting from the return to a fixed exchange rate at the prewar gold standard parity in 1925.' Despite some agreement on the magnitude of overvaluation in 1925 and a consensus that the overvaluation was greater in 1920, the absence of consistent data has resulted in the co-existence of a number of views that are clearly contradictory. For example, David Greasley and Les Oxley argue that the sterling real exchange rate became overvalued mainly during World War I.2 Nicholas Dimsdale reports that the real effective exchange rate appreciated significantly over the period 1921-1925, whilst B. P. A. Andrews finds a real effective exchange rate peak in 1920, followed by a cycle of depreciation until 1922 and appreciation over 1922-1925.3 absence of agreed data means that we cannot seriously evaluate how the exchange rate overvaluation affected aspects of the British economy during the 1920s. main study of Britain's real effective exchange rate during the 1920s is John Redmond's The Sterling Overvaluation in 1925: A Multilateral Approach, which evaluates the degree of overvaluation in 1925 relative to 1913 from a purchasing power parity perspective. There are four main problems with Redmond's study that we wish to address here. First, Redmond uses a variety of weights (derived from trade data for 1925, 1928, and 1929) and finds that the effective exchange rate indices are not sensitive to the weights used. However, the volatility of exchange rates and prices during the transwar period means that the choice of weights does matter over that period. To deal with this we work with trade weights from 1920 and 1925.4 Secondly, Redmond used arithmetic averaging to derive the effective exchange rate index. In light of modern conventional practice, we work with geometric averaging.5 Thirdly, Redmond used consumer and wholesale price indices constructed by the League of Nations during the interwar period. There are some major discrepancies between the