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Monetary Sovereignty, Exchange Rates, and Capital Controls: The Trilemma in the Interwar Period

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  • Obstfeld, Maurice
  • Shambaugh, Jay C
  • Taylor, Alan M

Abstract

The interwar period was marked by the end of the classical gold standard regime and new levels of macroeconomic disorder in the world economy. The interwar disorder is often linked to policies inconsistent with the constraint of the open-economy trilemma - the inability of policy-makers simultaneously to pursue a fixed exchange rate, open capital markets, and autonomous monetary policy. The first two objectives were linchpins of the pre-1914 order. As increasingly democratic polities faced pressures to engage in domestic macroeconomic management, however, either currency pegs or freedom of capital movements had to yield. This historical analytic narrative is compelling - with significant ramifications for today’s world, if true - but empirically controversial. We apply theory and empirics to the interwar data and find strong support for the logic of the trilemma. Thus, an inability to pursue consistent policies in a rapidly changing political and economic environment appears central to an understanding of the interwar crises, and the same constraints still apply today.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4353.

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Date of creation: Apr 2004
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Handle: RePEc:cpr:ceprdp:4353

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Keywords: exchange rates; monetary policy; trilemma;

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References

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  1. Pablo Emilio Guidotti & Guillermo Calvo, 1991. "Speculative Attacks," IMF Working Papers 91/10, International Monetary Fund.
  2. Maurice Obstfeld & Jay Shambaugh & Alan Taylor, 2004. "The Trilemma in History: Tradeoffs among Exchange Rates, Monetary Policies, and Capital Mobility," International Finance 0407003, EconWPA.
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  13. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Stochastic Process Switching: Some Simple Solutions," Econometrica, Econometric Society, vol. 59(1), pages 241-50, January.
  14. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August.
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  18. Maurice Obstfeld & Alan M. Taylor, 1999. "The Great Depression as a Watershed: International Capital Mobility over the Long Run," NBER Working Papers 5960, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Kirsten Wandschneider & Nikolaus Wolf, 2010. "Shooting on a moving target: explaining European bank rates during the interwar period," International Journal of Economics and Business Research, Inderscience Enterprises Ltd, vol. 2(1), pages 31-48, January.
  2. Julian di Giovanni & Jay C. Shambaugh, 2006. "The Impact of Foreign Interest Rates on the Economy: The Role of the Exchange Rate Regime," IMF Working Papers 06/37, International Monetary Fund.
  3. Ashraf Nakibullah, 2011. "Monetary Policy and Performance of the Oil-Exporting Gulf Cooperation Council Countries," International Journal of Business and Economics, College of Business, and College of Finance, Feng Chia University, Taichung, Taiwan, vol. 10(2), pages 139-157, August.
  4. Taylor, Alan M & Wilson, Janine, 2006. "International Trade and Finance under the Two Hegemons: Complementarities in the United Kingdom (1870-1913) and the United States (1920-30)," CEPR Discussion Papers 5846, C.E.P.R. Discussion Papers.
  5. GRENADE, Kari & MOORE, Winston, 2008. "Co-Movements Between Foreign And Domestic Interest Rates In A Fixed Exchange Rate Regime: The Case Of The Eccu And The Us," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 8(1), pages 119-130.
  6. Caroline Duburcq, 2010. "The Impact of Exchange Rate Regime on Interest Rates in Latin America," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 47(135), pages 91-124.
  7. Caroline Duburcq & Eric Girardin, 2010. "Domestic and external factors in interest rate determination: the minor role of the exchange rate regime," Economics Bulletin, AccessEcon, vol. 30(1), pages 624-635.
  8. Taylor, Alan M, 2010. "Global finance after the crisis," Bank of England Quarterly Bulletin, Bank of England, vol. 50(4), pages 366-377.
  9. Maurice Obstfeld & Jay C. Shambaugh & Alan M. Taylor, 2010. "Financial Stability, the Trilemma, and International Reserves," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 57-94, April.
  10. Wandschneider, Kirsten, 2008. "The Stability of the Interwar Gold Exchange Standard: Did Politics Matter?," The Journal of Economic History, Cambridge University Press, vol. 68(01), pages 151-181, March.
  11. International Monetary Fund, 2005. "Following Germany's Lead: Using International Monetary Linkages to Identify the Effect of Monetary Policy on the Economy," IMF Working Papers 05/86, International Monetary Fund.
  12. Masato Shizume, 2007. "A Reassessment of Japan's Monetary Policy during the Great Depression: The Constraints and Remedies," Discussion Paper Series 208, Research Institute for Economics & Business Administration, Kobe University.
  13. Taylor, Alan M. & Wilson, Janine L.F., 2011. "International trade and finance: Complementaries in the United Kingdom 1870-1913 and the United States 1920-1930," Journal of International Money and Finance, Elsevier, vol. 30(1), pages 268-288, February.
  14. Thomas Plümper & Vera E. Troeger, 2006. "Fear of Floating and the External Effects of Currency Unions," The Institute for International Integration Studies Discussion Paper Series iiisdp181, IIIS.
  15. repec:ebl:ecbull:v:30:y:2010:i:1:p:624-635 is not listed on IDEAS

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