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

  • Maurice Obstfeld

    (Economics Department, University of California, Berkeley & NBER)

  • Jay C. Shambaugh

    (Department of Economics, Dartmouth College)

  • Alan M. Taylor

    (Department of Economics, University of California, Davis & NBER)

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 often is linked to policies inconsistent with the constraint of the open-economy trilemmathe inability of policymakers 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 compellingwith significant ramifications for today's world, if truebut 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 EconWPA in its series International Finance with number 0407008.

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Length: 41 pages
Date of creation: 15 Jul 2004
Date of revision:
Handle: RePEc:wpa:wuwpif:0407008
Note: 41 pages
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