Relaxing the External Constraint: Europe in the 1930s
This paper documents the effects of exchange rates and the external
constraint during the interwar years. In the absence of international policy
coordination, exchange rate depreciation is shown to have been a necessary
precondition for the adoption of policies promoting recovery from the Great
Depression. But currency depreciation was not without costs. It increased
the variability of nominal exchange rates and rendered them increasingly
difficult to predict. Increased variability and uncertainty about nominal
exchange rates carried over to short-term changes in real exchange rates as
well. Thus, exchange rate variability appears to have introduced additional
noise into the operation of the price mechanism.
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