Interwar History
After the Gold Rush

There has been increasing interest in the interwar period and the lessons it suggests for current policy. In a paper presented at the recent CEPR/NBER policy coordination conference and now available as Discussion Paper No. 29, Research Fellow Barry Eichengreen reconsiders the history of the international financial system to see what light it sheds on the issue of international policy coordination. He first examines how contemporaries viewed the role for policy coordination at the start of the interwar period, taking as a case study the Genoa Economic and Financial Conference of 1922. Eichengreen argues that the advantages of policy coordination were in fact well understood in the 1920s, but political disagreements impeded moves towards a framework for cooperative action.

What effect did the resulting non-cooperative behaviour have, once the gold standard was again in operation? The gold exchange standard resembled a 'rules-based' regime, an attempt to minimize the need for policy coordination by limiting policy-makers' discretion. Eichengreen argues that the gold standard constrained but by no means eliminated the authorities' options. He develops a two-country model designed to highlight the scope for strategic behaviour by governments under the gold standard. The model characterizes behaviour of the banking sector as well as aggregate supply and aggregate demand in each country. Capital is mobile and financial assets are perfect substitutes, resulting in a common interest rate in the two countries. The model is completed by equations describing each government's policy objectives, which include both domestic price stability and the country's share of the world gold stock.

The two governments can engage in either cooperative or non- cooperative behaviour in setting their discount rates. Eichengreen's model suggests that non-cooperative behaviour imparted a deflationary bias to the system. Governments increased their discount rates in the attempt to capture more of the world's gold, depressing domestic activity. Since not all governments could increase their share of gold reserves at the same time, their attempts to do so were offset by higher discount rates in other countries, resulting only in further deflation worldwide. Cooperative behaviour, through coordination of discount rate policies, would have eliminated this deflationary bias. Despite the absence of dynamics and expectational effects, the model also helps in understanding why cooperative solutions proved so difficult to achieve.

The lessons of this experience with non-cooperative strategies were reflected in the next attempt to reconstruct the international monetary order: the Tripartite Monetary Agreement of 1936. This agreement resembled closely the Genoa Resolutions of 1922 but was more successfully implemented, because political circumstances had changed and the scope for collaboration was more tightly circumscribed. Thus the history of international financial collaboration in the interwar period sheds light not only on the rationale for policy coordination but also on the political and economic circumstances which might promote it.

International Policy Coordination in Historical Perspective: A View from the Interwar Years
Barry Eichengreen

Discussion Paper No. 29, September 1984 (IM)