Monetary Sovereignty, Exchange Rates, and Capital Controls: The Trilemma in the Interwar Period
University of California, Berkeley - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
Dartmouth College - Department of Economics; Georgetown University - Department of Strategy/Economics/Ethics/Public Policy
Alan M. Taylor
University of Virginia - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
CEPR Discussion Paper No. 4353
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.
Number of Pages in PDF File: 45
Keywords: Trilemma, exchange rates, monetary policy
JEL Classification: F33, F41, F42, N10working papers series
Date posted: May 18, 2004
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