Notes – 3. The Inter War Period
Review of WWI
Governments end war with huge debts, most economics flooded with liquidity
U.S. was the major creditors; U.S. credit financed allies imports during the war; the loans ceased at the
end of the war and the U.S. demanded repayments (so did UK). French tied repayment to reparations
from war damage by the Germans. So lack of funds for reconstruction, wrangle over repayment &
reparations – (sharp contrast with post-WWII actions and attitudes)
Excess liquidity depreciation of currencies inflation (mini boom)
Reparations: sources of resent, bitterness & hostility. Reparations was in the treaty but the exact
amount (enormous, including damage & pension, etc.) was determined later on. Senseless to weaken
Germany given her importance in the European economy German revenge.
General Overview of the inter-war period
Worst of all sub-periods (1890 – 1913; 1914 – 1951; 1951 – 1973; 1973 – 1994)
Instability – lots of ups and downs
Feistein, Temin & Toniolo’s observed stylized facts:
Although phenomenon was worldwide, slowdown in certain areas (Europe) was much more
Breaking the period down in half; 1920s was much better than 1930s. However, with the exception
of France and the U.S. belligerents during the war performed poorly in the post-war years.
International trade declined in real terms; trade as a percentage of output declined worldwide
even though with more states (11-22% between 1870 and 1913, but 15% by 1929 and 9% by 1938);
High unemployment (structural + slow growth in AD). Question: labour market rigidities + high
dole contributing factors?
Higher labor productivity than previous periods.
Exports among some European countries lagged 1913 levels throughout the inter-war period – only
some countries, key countries: UK, Germany, Austria, USSR?
Taylor et al:
Payment frictions – clumsy recreation of the gold standard;
Transport cost increases: TFP growth lagged transport; maritime transportation concentrated thus
higher prices; more organized and powerful labor higher wage costs; return to protection
O’rourke et al:
Change in commercial policy; collapse of the gold standard; evaporation of commercial credit;
Unsuccessful efforts (two Geneva conferences in 1927)
Hawley-Smoot tariff – U.S.; quota – France (rent-seeking); exchange control - Germany
Emigration pressure remains high in European but receiving countries changed, esp. U.S.
Escalating immigration quota (3% - 2%) – 25% of pre-war totals (270,000); 44,000/yr in 1930s;
Canada, Australia, Argentina, Brazil – still receive large number in 1920s;
In 1930s worldwide drop in emigration; world-wide inflation;
The greatest force for convergence prior to 1914 was diminished.
Capital flows International capital flow trace a U shape (1913 – 2000) with 1945 as the trough.
Why decrease in international capital flow? Trilemma problem. During the inter-war period, either
the fixed exchange rate or the capital mobility had to go – in pursuit of a independent domestic
Obstfeld & Taylor:
The fall-off in capital mobility was the result of political decisions, not the consequence of
technological regress or other changes;
Pre-war: stable gold standard, interest rate spreads was small. Inter war; interest rate spreads
sensitive to the size of the government debt; better to devalue than deflationary policies. Peg
would not hold.
Technical Change/Labor productivity
One remarkable feature of the inter war period;
Participation rates dropped;
Stronger unions pushing for shorter work hours;
Unemployment get rid of low productivity ones;
Two general purpose technologies (electricity and automobiles)
War contributed to technological development in certain areas: aviation, chemicals, engineering;
Automobiles; comes with it consolidation; realization of scale economics; production lines,
standardized parts – Fordist production techniques;
Consumer durables (esp. U.S); radios, refrigerator;
1930s were even more technologically progressive:
Synthetic fibers-rayon; diesel fuel in shipping; synthetic chemicals, etc.
Implication: lower demand for coal & textile traditional industries had to be allowed to
decline and new ones allowed to replace them. – Creative destruction.
What role did the government play in this process? Resistance? Facilitate change and provide
assistance to those hurt by the change
A few words on agriculture
Continuous decline in the price of most agricultural commodities in the 1920s and 1930s, esp. wheat &
sugar. Sharpe increases in prices during the war expansion of land under wheat cultivation supply
exceeds demand response? Duties. X! wrong response. (Smoot-Hawley initially viewed as help
Contradicts this view: commodities other than wheat & sugar?
Main question: Why was the overall economic performance of a number of key countries in the inter-
war period so poor?
Shift of capital & labor from war to peacetime production; from agriculture and primary production
Stronger trade unions created wage rigidities;
Excess capacity in a number of sectors – armaments; shipbuilding call for protection & subsidy;
Larger business units greater political clout collusion; cartelization (UK & Germany).
Competition is what encourages restructuring, not the lack of it price rigidity; less pressure to
Government protected what needed to be eliminated/competed (textiles in Britain)
Lack of central bank leadership No longer London, not yet Washington. – subsidiary role to the problem of cooperation.
Lack of international cooperation
Problems need cooperation: reparations; settlement of inter-allied war debts; return to gold;
Symbol of failure: world monetary conference of 1933 – Roosevelt said that U.S. was unwilling to
participate (unprepared any longer to support deflationary policies to maintain the gold standard)
Old-fashioned ideologies (the gold standard)
All European countries obsessed with the need to return to the gold standards since politicians and
economists (most but not all) seemed to believe that it would resolve all problems.
Return to gold at the pre-war parities would require huge domestic adjustments
Most believed that the gold standard was responsible for the pre-WWI prosperity – now we know
the causality went the other way – Keynes said it, on one listened to him.
b) Reparations & Hyperinflation in Germany
At the end of the war, Germany’s imperial government collapsed. Serious social, political, and economic
unrest in the country (1919 Munich & Berlin uprisings)
Germany was excluded from peace treaty deliberations in Versailles (in violation of treaty agreement);
New government was forced to accept full responsibility for the war; compelled to make substantial
territorial concessions & pay reparations – condemned & blamed by the German public
Politically a mess (messy elections; social democrats withdrew from the government; cabinet resigned)
Financially ruined (an expensive war; government was heavily indebted; agricultural output was down;
British blockade + price controls that led to hoarding food crisis
Treaty of Versailles:
Territory lost (major sources of coal and iron and important food growing areas)
Colonies lost; all public property in the ceded territories and colonies lost;
Merchant marine taken;
All German property in the Allied countries were confiscated without compensation, as well as the
property of German nationals in the territories of Germany’s former allies;
5 years of compelled MFN treatment & can’t restrict imports;
In-kind payments: coal; chemicals; timber, etc.
Reparations issue was initially settled in Jan 1921; $269 billion gold marks – later reduced to $132
billion gold marks….so..much..money..
Issues of Reparations
Question: could Germany make the payments? – Transfer of real assets = mortgage its future to meet
Loss of overseas assets and the loss of her merchant marine meant that Germany’s exports of invisibles
would drop and she would be compelled to import more shipping services.
German government had to meet all these payments and it also had to compensate its nationals for
everything seized and transferred by/to the allies.
Think about it as a sovereign debt crisis:
62 million population; 300% of 1913 GDP; reparations debt per capita > GDP per capita;
Three layers of reparations:
A – 12 bn. Gold marks to compensate for war damages;
B – 38 bn. Gold marks to compensate for inter-allied war debt;
C – 82 bn. Gold marks Strictly punitive. If just look at A+B (C will probably never be paid), total debt to GNP for Germany not much
different than F or B. So what’s the big deal here about reparation?
The problem is Germany’s debt is largely foreign owned while debts of F and B are domestically
owned. So according to Ritschl, it’s unwillingness to pay rather than transfer problem.
It boils down to a question of whether the cost of paying reparations exceeded the cost of defaulting.
How to pay foreign debt:
Current account surplus accumulate foreign exchange;
Losing markets to Germany?
Money supply increases price level increases
Borrow abroad could only postpone the problem.
Tax; but who pays taxes? Who is going to shoulder the costs of austerity?
Germany began paying in 1921, both in cash & in kind; in 1922 announced it’s too much so the amount
got reduced. On Dec 26, 1922, Germany declared in default by reparations. Jan 1923 French and
Belgium troops march into the Ruhr.
Passive resistance from Germany, supported by the government something else was needed;
Dawes Plan: loan from the U.S.; but make commercial credit the senior debt and reparations the junior
debt. Moreover, reduced the amount to be transferred; saw to the transfer difficulties.
Germany borrowed heavily; since commercial credit was senior and interest was high; lenders were
willing to lend. Big inflow of funds for infrastructure & other low productivity investments.
Use loans to pay reparations obligations Ponzi Scheme
Young Plan: reversed the seniority of debts – commercial junior to reparations. Fed raised interest rates
in the U.S.; credit flowed out of Germany.
Germany’s situation: want to be part of international community had to meet debt obligations tax
& cut imports. Alternative? Autarky + default on its reparations debt.
Benefits: get rid of the huge debt
Cost: not that high; trade is falling anyway;
But Bruening did not follow this path and was forced f