Barry Eichengreen and Peter Temin 2010

Introduction we avoided a catastrophe like the Great Depression Thanks to aggressive use of monetary and fiscal stimuli Great Depression resulted from the prevalence of fixed exchange rates They argue that fixed exchange rates work in good times but intensify problems when times are bad They also describe why the gold standard and the euro are extreme forms of fixed exchange rates

The gold standard and the euro decisions reflected deep-seated historical forces that developed over long periods of time The gold standard was seen as the normal basis for international monetary affairs a process of European integration with roots stretching back well before the Second World War that came into full flower in the fertile seedbed that was the second half of the twentieth century

The Gold Standard Free flow of gold between individuals, countries, the maintenance of fixed values of national currency in terms of gold and therefore each other Penalty for running out of reserves, while no penalty for accumulating gold Deflation was the adjustment mechanism, rather than devaluation Robbins argued that wages, not just prices, had to be flexible to reduce unemployment

The euro Eliminated all national currency In theory, an incumbent member could opt to reintroduce their national currency If they did, they would have to convert all financial assets and liabilities of residents Investors would get their money out of the country creating the mother of all financial crises

Back to the Gold Standard Tight monetary and fiscal policies of the late 1920s that induced investment to fall were due to the adherence of policy-makers to the ideology of the gold standard During the 1930s, the gold standard had to be maintained preliminary prerequisite for prosperity

Distributional Conflict and Tenuous Resolution Germany: Hyperinflation …Dawes Loan/Agent- General for Reparations Payments Dont raise taxes lest reparations could be paid France: Inflation – Political Gridlock – Poincare Stabilization …Taxes and Undervaluation UK: Deflation – Return to Gold – General Strike … Gold Standard Abandoned

World gold reserves Total gold reserves rose from 1927 to 1935 US gold reserves jumped dramatically after 1933 Frances gold reserves rose then declined UK and Germany had little reserves, Germanys vanished in 1931

The Great Depression Economic policies did not alleviate the Depression; they worked to intensify it They were formulated to preserve gold, not to stabilize output and employment Central banks stood ready to withstand financial panics but no to preserve output or employment

The euro and the renminbi Adopting the euro was an absolute rather than a contingent commitment Countries could leave the gold standard, but countries cannot temporarily abandon the euro in times of crises The Maastricht Treaty hardly mentioned member state reintroducing their own currencies The euro area talked the talk, but did not walk the walk, of international cooperation

There was awareness that fiscal and financial policies were of concern and that there had to be some adjustment when countries had chronic surplus and chronic deficit Talk the talk… walk the walk Europe also lacked an emergency financing facility to provide assistance to countries in financial difficulties Austria and Greece BIS…EFSF…IMF China Undervalued currency Moving workers from low-productivity agriculture to high- productivity manufacturing, and selling to high income consumers

Towards symmetry Germany (post-WWI), Greece, and the US lived beyond their means running budget and current- account deficits financed by borrowing Pegged exchange rate eliminated currency risk encouraged finance to flow from capital-abundant economies to capital-scarce economies Capital flow bonanza followed by sudden stop Solution: countries on the receiving end need to exercise more restraint, eliminate excessive deficits…but deflation (internal devaluation) heightens debt burden Surplus countries need to expand demand

The point is that an exchange-rate system is a system, in which countries on both sides of the exchange-rate relationship have a responsibility for contributing to its stability and smooth operation Cannot realistically assign all responsibility for adjustment to the deficit countries. Keynes wanted taxes and sanctions on chronic surplus countries in the clearing union proposal that he developed during the Second World War. Sixty-plus years later, we seems to have forgotten his point