The unpleasant legacy of the crisis: public debt and low trend growth in the Eurozone

Nicholas Crafts interviewed by Viv Davies, 21 Jan 2014

Nicholas Crafts talks to Viv Davies about his recent work on the threatening issue of public debt in the Eurozone. Crafts maintains that the implicit fault line in the EZ is evident; several EZ economies face a long period of fiscal consolidation and low growth and that a different sort of central bank might be preferable. They also discuss the challenges and constraints of banking, fiscal and federal union. The interview was recorded in London on 17 January 2014.


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See Also

Crafts, N (2013b), “Saving the Euro: a Pyrrhic Victory?”, CAGE-Chatham House Policy Briefing Paper No. 11.


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Topics: Economic history, Macroeconomic policy
Tags: debt monetisation, ECB, eurozone, financial repression, fiscal consolidation, gold standard, public debt

The Eurozone: If only it were the 1930s

Nicholas Crafts, 13 December 2013



The 1930s deservedly have a bad name. It is hard to imagine that a decade that included the Great Depression and a major de-globalisation of the world economy, and culminated in WWII could be other than notorious. And yet, compared with struggling Eurozone economies today, the economic situation in Europe in the later 1930s was in many ways more promising.

Topics: Economic history, Macroeconomic policy
Tags: debt monetisation, ECB, eurozone, financial repression, fiscal consolidation, gold standard, public debt

Gold prices depend on market microstructure

Stefano Ugolini, 5 July 2013



The gold standard is an evergreen in monetary-policy debates. The current expansionist stance adopted by central banks has provoked its return to centre stage (see e.g. Harrison 2013):

Topics: International finance
Tags: gold standard

Currency stabilisation and asset-price anchors: An examination of medieval monetary practices with some implications for modern policy

Anthony Hotson, 23 April 2013



Mints as off-balance-sheet intermediaries

Topics: Economic history
Tags: Bank of England, bullion, consumer price index, gold standard, Mint

What caused the recession of 1937-38?

Douglas Irwin, 11 September 2011



The recession of 1937-38 is sometimes called “the recession within the Depression.” It came at a time when the recovery from the Great Depression was far from complete and the unemployment rate was still very high. In fact, it was a disastrous setback to the recovery.

Topics: Economic history, Global crisis, Macroeconomic policy, Monetary policy
Tags: gold standard, Great Depression, monetary policy, recession, US

Gold standard or political discipline?

Andreas Freytag, Stan du Plessis, 12 November 2010



In the wake of the global financial crisis, uncomfortable exchange-rate adjustments along with large capital flows are straining international economic co-operation. The policy proposals are many, whether in the form of capital controls, guidelines for current account balances, or most recently a return to the gold standard.

Topics: Global economy, Monetary policy
Tags: exchange-rate policy, global imbalances, gold standard

Did France cause the Great Depression?

Douglas Irwin, 20 September 2010



A large body of economic research has linked the gold standard to the length and severity of the Great Depression of the 1930s, primarily because fixed exchange rates precluded the use of monetary policy to address the crisis (see for example Temin 1989, Eichengreen 1992, and Bernanke 1995)

Topics: Economic history, Global crisis, Monetary policy
Tags: France, gold standard, Great Depression, US

The gold standard and the eurozone crisis

Richard S. Grossman interviewed by Romesh Vaitilingam, 21 May 2010

Richard Grossman of Wesleyan University talks to Romesh Vaitilingam about the role of gold standard in propagating the Great Depression – and what we might learn for the crisis in the world’s most important fixed exchange rate system of today, the eurozone. The interview was recorded at a conference on ‘Lessons from the Great Depression for the Making of Economic Policy’ in London in April 2010.


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Further related research here [1]. [1]


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Romesh Vaitilingam interviews Richard Grossman for Vox

April 2010

Transcription of an VoxEU audio interview []

Romesh Vaitilingam: Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam, and today's interview is with economic historian Professor Richard Grossman from Wesleyan University. Richard and I met in London in April 2010 at a conference on lessons from the Great Depression for the making of economic policy. Richard had presented some work on the role of the gold standard in propagating the Great Depression, and that's where we began our conversation.

Richard Grossman: The British had been on the gold standard for quite some time. They returned to the gold standard after the Napoleonic Wars, and were, along with Australia, Canada, and Portugal and were really the only countries on the gold standard until the 1870s. And at that point the Germans, flush with money that they had received from the French after the Franco Prussian War, went back to the gold standard. This sort of led to a stampede of countries going to the gold standard. So Germany, during the decade of the 1870s...

The way the gold standard works is that a country fixes the value of its currency in terms of a quantity of gold. Then, of course, any two countries that have their currencies fixed to a certain quantity of gold, that becomes the exchange rate between those two currencies.

And so, the gold standard became the main international monetary basis from sometime during the 1870s. The gold standard is consequently a fixed exchange rate regime, and that brings some problems with it. It constrains a country in terms of what it can do with its domestic monetary policy.

For example, if a country is running a balance of payments deficit, then that means that it's exporting gold. It can't maintain that forever, because eventually it will run out of gold reserves.

And so, what it has to do is something to attract gold back now. They can sell assets that they own abroad, or they can borrow, but eventually those, too, are going to run out as sources of gold. So, what they'll eventually have to do is maybe raise interest rates to attract short term capital flow.

But, if you're running a persistent balance of payments deficit, and you're under a fixed exchange rate system, really the only thing you can do is try to reduce the value of your exchange rate, which means deflation in terms of exportables.

Now, that means that you have to run contractionary monetary policy, which can have very serious side effects for the economy, and leads to what people have said was sort of sacrificing the domestic economy on the altar of the gold standard.

So that's the set up of the gold standard. After World War One, the British went back to the gold standard at their pre war parity, but in the interim, there had been a great deal of inflation, more so than with a number of other countries. And so, the British currency was overvalued, and so the British ran a persistent balance of payments deficit throughout the 1920s, and continuously had to maintain high interest rates to attract gold, and to push down the price of exports.

John Maynard Keynes famously wrote about this in his "The Economic Consequences of Mr. Churchill." In the United States, it was called, "The Economic Consequences of the Gold Standard." Perhaps Americans in the '20s didn't know much about Churchill.

So basically the British, who returned to the gold standard in 1925, ran contractionary, or very tight monetary policy throughout most of the 1920s. Consequently, they were an intractable million unemployed, and there was a general strike in 1926, and a coal strike also. Again, the effort was to push down the price of exports.

This lasted until 1931, when finally, it became unsustainable. There was a financial crisis on the continent, and eventually pressure fell upon sterling, and the British ended up going off the gold standard in 1931.

What that allowed Britain to do was to run a much looser monetary policy, which helped it enormously during the 1930s, compared with, say, the French, who didn't devalue until later in the '30s, until after 1935. I think it was 1936. By fact, by law it was sometime later.

What you find is that countries that maintained their gold parity, that is that didn't leave the gold standard, did worse than countries that did. So, the British did relatively well after leaving the gold standard. A number of other countries did well after leaving the gold standard. Places like France and the Netherlands, they stayed on the gold standard for much longer, and they didn't do well.

Romesh: So effectively, it was a competitive devaluation. They were forced off it, but in fact it was very beneficial for the economy.

Richard: Exactly, and Eichengreen and Irwin have made this argument recently, that one of the reasons why some countries put on high tariffs is because they didn't devalue, and the only way that they could maintain balance of payments equilibrium was by putting a tariff on imports. And so, that would explain why some countries did that. I'm not fully on board with that, only because I haven't studied it, but that is one view that's current at the moment.

Romesh: What can we learn from the experience of the gold standard for the crisis we're in now, where the big fixed exchange rate regime is the Eurozone, and whether our big issue is being discussed right now, about how to respond to the problems of potentially breaking up the Eurozone?

Richard: Absolutely. Now I know that there's been some work recently on can the Euro, in fact, break up? I imagine that legally, it's possible. I don't know whether it's feasible economically. My old mentor, Barry Eichengreen, is quoted as having said that it will lead to the mother of all financial crises. The problem with a fixed exchange rate regime is that is basically ties the hands of monetary policy makers. So, Europe has one monetary policy, and Europe is composed of a variety of countries that have different needs. If the needs of countries, say more on the periphery, the PIGS, are different, somewhat, than the needs of countries that are closer to the center, say, oh, let's say Germany.

So, I think that there is an inherent problem in that the monetary policy that's good for Germany may not be the monetary policy that's good for Greece. Now, Greece has a number of other problems. There's been a fair bit of mismanagement, and there are other underlying issues that have to be straightened out.

So, the solution that's been offered by people like Barry Eichengreen and Paul Krugman has been that instead of backing out, we need to go further in. That is, to have greater fiscal federalism, and that the approach should be to bail Greece out, or to bail the PIGS out, but to make the loans come with conditions to prevent to recurrence of the various wrongs that were perpetuated by policymakers.

So the idea would be that to give assistance conditional on certain behavior, and that during the meantime to encourage fiscal federalism so that Europe... The thing is, Europe is a number of different countries with one monetary policy, one currency, but however many different governments making fiscal policy.

And so, while having one whole market is a very good idea, having a single market is a wonderful idea, but you now have single markets with one monetary policy, but separate fiscal policies. I think that leads to some difficulty.

And so, there are also wide differences in how well fiscal policy is made, not just in the needs of fiscal policy, but in how well policy is adapted and how well governments work.

And so, I think that one way out it may be the only feasible way out is to have greater fiscal federalism, transfer more authority to the central authority in the European Union.

Well, I understand that this is not... This is another part of giving up sovereignty, and handing over your currency is losing one form of sovereignty, but it's sort of like going half in. I think, at this point, the best thing for Europe may be to have a little bit more...I mean, I don't have an endpoint. I don't have a model of where this should go, but certainly, I think they need more fiscal federalism for the single market to work, and for there to be more harmonization. And that was the idea before going in, that there be more harmonization, and so that countries would maintain certain fiscal postures.

That's hard, so either there have to be either community or union wide rules, or else there has to be more in the way of central authority. These are very thorny problems, and I... This is just a sort of general approach, just what one might do to get at them.

Romesh: Looking at historical perspective, what do you see as being the benefits of the fixed range rate system? On the one hand, you're saying if you devalue, that's a good way to come out recession. But at the same time, in the paper, you talk about exchange rate volatility, which is what you get with a floating rate system, actually damaging trade, but actually making it more difficult for economies to come out of recession.

Richard: It's true. This is one of those coins that has two sides. When you do have your own exchange rate, and you have floating exchange rates, you can devalue, and you can do beggar-thy-neighbor policy, so that your exports are more attractive. And so, in some sense, there is a certain benefit to that. But there's also the notion that if you are going to have this single currency, then obviously you can't do that anymore. The benefits, of course, are the single market. I don't pretend to be an expert on labor markets, or factor markets, or product markets in Europe, but I can imagine a situation, and I remember reading a paper about this some time ago, actually, it was in the popular press: They happened to be very efficient at making washing machines in one country in the European Union, and ovens in another one, and something else in another one.

But people weren't buying across borders. Some of it had to do with, still, barriers, in terms of trade and transportation costs. But some of it had to do with everything was priced a little bit differently, and you never knew what a washing machine from Belgium, or from Italy, or from Spain was going to be.

So, the argument, I think, in favor of a European Union in terms of currency is that it makes trade... It facilitates trade.

Again, there will be scholars who are far more immersed in the details than I and the history of the debate and the theory of the debate, but the notion is that you have a single currency, it takes a great amount of uncertainty out of transactions.

It does make it easier to do financial transactions. It makes it easier for some of the periphery countries we've been talking about to float sovereign debt, because it's done in this currency that everyone knows, and trusts, and recognizes.

So, I would say the benefits would be having a strong, a currency that is stronger than those of the individual components, and sort of efficiencies that economists like to talk about, but it's a lot harder to measure.

I think people who live on the borders, people who live near Mostrach, which is near Aachen...People who know about this--I have family members who live in Germany, and they sent a bunch of wedding invitations to family in Aachen so that they could mail them from Belgium or from Holland because the postage rates were lower than in Germany.

So, in the US, I know people who buy their gasoline in one state. I live in Massachusetts and work in Connecticut. I never buy my gas in Connecticut because the taxes on gas are higher.

So, I think the people who live in border regions understand this, and I think that the benefits of having a whole union are substantial, but again, it comes with cost, and the cost is this coordination, having monetary policies linked forever, which is a little frightening, but that's the way it is.

Romesh: For our final question, related. The policy response to this Great Recession, compared to the Great Contraction, globally seems to have been better, more effective. Would you agree with that?

Richard: I would. I think that, first of all, not having to worry about the gold standard so much, at least for the US, has made it much easier to undertake expansionary monetary policy. I should add that this is not new. The Bank of England was doing this in the 19th Century, and there's a wonderful quote from someone at the Bank of England in 1825. He's talking about, "We lent money by every conceivable way we could and on as fine a line as we could, and on some occasions, we were not over nice."

I think that's sort of the Fed, and a number of the other central banks have taken very orthodox and unorthodox approaches to getting money out there.
Fiscal stimulus, I know a little bit more about what's going on in the United States, but there has been substantial fiscal stimulus. So, I would say policy response, I would say, has been much more surefooted. I think that the lessons that we get from looking back at the Great Depression is that people who complain about...

And again, in the US, this is quite common. People say, "Oh, there's too much government and too much..." I think, at this point, we need to have activist fiscal policies. We need to have expansionary monetary policies, and I think that the lesson of the Great Depression is that we did not have activist enough government. We did not have flexible enough monetary policy. We're doing a better job of those things right now.

And so, I think that's a great benefit. We don't want to over-learn the lessons of the Depression. We want to just take that as an experience that we can use, just as we would use the experience from more recent history in making better policy decisions.

But the thing that's useful about the Depression is it's an example of an extremely severe financial and economic crisis similar to what we have today. I would argue that what we have today is not nearly as substantial as the Great Depression, but it's a useful laboratory for examining these questions.

Romesh: Richard Grossman, thank you very much.

Richard: Thank you.

Topics: Economic history, Exchange rates, Macroeconomic policy
Tags: eurozone, gold standard, Great Depressino

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