Purchasing Power Parity and the Pound-Dollar Rate in the 1930s

Abstract

Opponents of flexible exchange rates have stressed their volati lity during the 1930s, while advocates of flexible exchange rates have stressed their relationship to fundamental economic variables. The author reconciles the two views, allowing that although exchange rates did move to preserve pruchasing power parity in the long run, there could be substantial deviations from purchasing power parity in the short run. For the pound-dollar rate, the source of the large fluctuations in the early 1930s lay in the asymmetric response of foreign-exchange markets to fluctuations in Britain and America while the latter adhered to the gold standard. Copyright 1987 by The Review of Economic Studies Limited.