Exchange Rate and Output in the Aftermath of the Great Depression and During the Transition Period in Central Europe

The author compares the influence of the exchange rate on economic activity during two distinct historical episodes: the aftermath of the Great Depression and the second stage of transition in Central Europe (1994–1998). The main hypothesis is that benefits from devaluation may actually be derived from the coordination of international economic policy. This is an important distinction because benefits from devaluation lead to the policy prescription “if all devalue, everybody is better off,” while benefits from coordination lead to a much more carefully implemented exchange rate policy. The author finds that large devaluations/depreciations in transition countries always seem to be detrimental to growth, while small fluctuations in the exchange rate seem to support various output scenarios, depending on the initial conditions and/or the speed of market reforms (where the latter depend on the former) and historical circumstances (such as membership in the FSU). Where seeming benefits from devaluation did appear, they may have occurred simply because some small and open economies had successfully coordinated their monetary policies with their main trading and financial partners. Many of the “benefits” from devaluation in the aftermath of the Great Depression can be attributed to the successful coordination between the Scandinavian countries and their main trading partner – Great Britain. From a comparison of two very distinct historical episodes, the author concludes that devaluation is not a good strategy for an individual country and the approach “if all devalue, everyone is better off” cannot automatically be established as a policy prescription. In many cases, the costs of devaluation may exceed the benefits. The results in this paper point beyond the usual economists’ credo that no single currency regime is right for all countries at all times. The results indicate that the international propagation mechanisms and the issues of international economic policy coordination are crucial in determining the impact of devaluation.