International Monetary Instability Between the Wars: Structural Flaws or Misguided Policies?

Abstract

This paper reassesses the history of the international monetary system between the wars. It confirms the generality of several widely held interpretations of recent experience with floating exchange rates. There is a positive association between nominal exchange rate variability and real exchange rate variability. But policies of intervention which reduce nominal exchange rate variability do not guarantee a proportionate reduction in nominal exchange rate risk or in real exchange rate variability and unpredictability. A credible commitment to a stable intervention rule is needed to deliver these benefits. The paper then goes on to consider four potential explanations for the collapse of the fixed rate regime that prevailed from 1926 through 1931: (1) failure to play by the rules of the game, (2) inadequate international economic leadership by the United States, (3) inadequate cooperation among the leading gold standard countries, and (4) structural features of a system in which reserves were comprised of both gold and foreign exchange. It concludes by assessing the role of the international monetary system in the Great Depression.