Stuck on Gold:Real Exchange Rate Volatility and the Rise and Fall of the Gold Standard, 1870?1939

Did adoption of the gold standard exacerbate or diminish macroeconomic volatility? Supportersthought so, critics thought not, and theory offers ambiguous messages. A hard exchange-rateregime such as the gold standard might limit monetary shocks if it ties the hands of policymakers. But any decision to forsake exchange-rate flexibility might compromise shockabsorption in a world of real shocks and nominal stickiness. A simple model shows how a lack offlexibility can be discerned in the transmission of terms of trade shocks. Evidence on therelationship between real exchange rate volatility and terms of trade volatility from the latenineteenth and early twentieth century exposes a dramatic change. The classical gold standarddid absorb shocks, but the interwar gold standard did not, and this historical pattern suggests thatthe interwar gold standard was a poor regime choice.