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Overview (AS and AD shocks)
Unemployment
Demand management: exchange rate and tariff
Demand management: domestic monetary and fiscal policy
Conclusions
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Overview (AS and AD shocks)
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We’ve left the comfortable world of pre-1914, when Britain was the richest country in the world, and it is very much
WW1 which disrupts that
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Narratives about decline start becoming more serious and it is in the interwar period where we learn 80-90% of our
economics lessons- The Great Depression/ Policy responses to this big, international event
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Pre-1914, Britain operated in a context which was
amenable to the types of industries which Britain participated heavily in: International services work better in a big,
integrated world market then in small, fragmented, national markets
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This was a predictable system that Britain operated- it was anchored by British banks (inc
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However, in the interwar period basically none of this
is true- Europe becomes increasingly chaotic and hostile & the financial order, which used to revolve around London
now becomes unanchored
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So two very different world, and WW1 is what
separates them
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This is not only a period of chaos and depression, it is also a period of transformation and
social change
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So the labour supply shrinks and the wage paid
per hour goes up - great for employed worker, bad for employers and unemployed because getting a job is now harder
as the wage you need to be paid is higher
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This is the period of the only general strike in British history
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This is the period immediately following the Russian Revolution: there is a sense of international hostility
between labour and management
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Here is where the union system of Britain, with multiple small craft unions, who
all negotiate separately, starts to become a problem
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Wages start to
become very inflexible
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(6) Benjamin & Kochin (1979) claim that high unemployment in the interwar period in Britain is a function of generous
unemployment benefits (B/W), which induced voluntary unemployment
Benefits led to higher unemployment
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Benjamin & Kochin (1979)
argued that unemployment was high because benefits were generous
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(7) Aldcroft & Richardson cite the following as key reasons for interwar unemployment:
Over-commitment to old staple industries in the pre 1914 period
Regeneration between wars with big structural adjustment
And labour wasn’t mobile between old and new industries
Other key reasons interwar unemployment
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Britain was overcommitted to staple industries: too much was left in textiles, ship-building and coal
mining and not enough in chemicals and automobiles and new industries
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There is a lot of structural adjustment which
has to be done: wars not only destroy a lot but also kill people, destroy capital and change the political situation
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3
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Wasn’t clear
that labour was super mobile between these industries- people had homes, families, existing jobs/ skills- this wasn’t the
US where people had a regular pattern of uprooting and moving
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Markets that
Britain used to make a lot of money out of, used to be a good soak for exports, and that Britain had very carefully
integrated itself into (in terms of providing both ships, and shipping; providing customised textiles, financial services)- all
of these things which Britain had concentrated on become way harder after WW1 because of the collapse of
international markets
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/ There is also domestically an investment crash, probably
related to the same phenomenons
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If you leave housing out of the picture, however, there is actually net disinvestmentBritain is not investing enough to even maintain its capital stock
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Policy implications can be seen in a few countries: investors flee to safety - they don’t
invest in equipment, factories or R&D
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(9) AD shocks
Money demand drops
Shift in liquidity preference in early 1920s meant that increased demand for money was matched by reduced willingness
to hold bonds
Government concern about borrowing throughout interwar period
Money market side of the investment story
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There is a shift in liquidity
preferences- people want to hold cash whereas before people were content to rely on flows coming in, so people hold
bigger stocks of cash
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Part of economic history where MP, FP
and investment all come together
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(10)
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Overview (AS and AD shocks)
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Overview
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(11) Unemployment rate: way back in 1920 UK still pulling out of a war-time economy, which isn’t a command economy
to the same extent as WW2, but there is still full employment
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(12) Aggregate unemployment
Interwar period clearly one of high unemployment!
Compared with full employment between WWII and the late 1960s (rarely > 2%)
Most other countries also suffered from high unemployment during the 1920s
Virtually all countries suffered from high unemployment during 1930s
Some of which was even higher than in Britain
Aggregate Unemployment
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Employers know workers need
the jobs and workers will use whatever force they have to keep them
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This
period was characterised by 10, or even 20% unemployment in some years
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The international demand shock, where British exports fail - foreign consumption drops as
unemployment is -20% abroad too
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This issue is bad in the 1920s and awful in the 1930s
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Almost all countries do worse than Britain- WW1 hit Britain
very hard and the 1930s are comparatively mild
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Unemployment is complicated and official figures aways conceal some
truth
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We’ll go into
some of these differences that will maybe tell us soothing about who is not in the labour market anymore, and who reenters it
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This is the beginning of the end for British textiles- 1914 was the high point
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Other staple industries which Britain used to be very good at are the ones that declined in terms of
employment the most
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Unemployment per industry is tricky: if
someone leaves the labour force it’s not clear if they are still unemployed in that same industry or whether they’re
looking for work in different industries: Not entirely clear how people are moving between industries
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It’s also not necessarily clear how people are moving between places
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Unemployment in North far more worse than that in Southso many move to London (we don’t know what industries/ sectors/ how many, though)
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(16) Differences by gender and age
Unemployment generally higher for men than for women
Although this is partly a registration problem (discouraged worker effect)
For both men and women, unemployment rates increased by age group
Unemployment higher for men than women
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Women probably much more
active in labour force from 1900-1920 than in 1950s
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Unemployment everywhere increases, though
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While shock hits both groups, the recovery only hits men
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Older men no longer competitive
against younger men, who are hired more frequently
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As people
stay out of labour force they are more outdated and less hireable
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(18) Macroeconomics of interwar unemployment
Three reasons suggested in literature for increase in natural rate:
Over-generous unemployment benefits
Rapid structural change
Real wage too high
Unemployment- Reasons For
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) 1) Benjamin & Kochin (1979) talked
about over-generous unemployment benefits
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3) Real wages too high (policy reasons/ union bargains fix the real wage at a level where
employers hire fewer people than would empty the pool of unemployed
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Evaluate
(19) Reason 1: Over-generous unemployment benefits
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Major piece of evidence is a time series regression, which they claim proves that benefits raised unemployment by
about 10%
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Benjamin & Kochin (1979) argue that it’s benefits: too much is being paid to workers in
1920s
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(20) Reason 1: Comments on Benjamin & Kochin
Ormerod & Worswick: claim that B&K’s equation is unstable, with regard to the sample period
If observations for 1920 and 1921 dropped, (B/W) becomes statistically insignificant
Effect on unemployment depends crucially on inclusion of 1920 and 1921 observations
But during this period, benefits were too low to have created benefit-induced unemployment…
Unemployment Reason 1
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They claimed it seemed to rely on data from
high unemployment periods in 1920 and 1921 to make the statistical claim that this is true
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Pulling these observations out
the effect (statistical significance) vanishes
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Collins has also attacked this story, saying that this doesn’t actually explain variation
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There is a
nationally fixed set of benefits but unemployment changes depending on industry
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(22) Reason 1: Comments on Benjamin & Kochin
Cross: system not generous in terms of the way it was administered
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This was harshly means-tested
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Benefits had a small impact and were stingy & hard to
get
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Evidence seems to suggest its not benefits increases which are increasing unemployment
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Aldcroft & Richardson (): Maybe a story of transition from old, labour intensive industries into
new, mechanised, high-tech industry
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(24) Reason 2: Structural change
However, von Tunzelmann shows that new industries were not less labour-intensive than old staples
In fact, the reverse true:
Ratio of (share of labour):(share of K) = 2 in new industries, but only = 1
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Unfortunately this argument also doesn’t work very well: old industries were actually less
labour intensive
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Brit was capital market of the world
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5:1, less labour for the same amount of capital
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(25) Reason 3: Real wage (W/P) too high
Critical change was the reduction in hours worked during 1919-20 (Dowie)
Weekly hours fell by 13%
From 54 to 47 hours
The increase in wages relative to labour productivity represented a substantial distributional shift in favour of labour
Once established, it proved very difficult for any firm or person to move to a different equilibrium
Unemployment Reason 3
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Firms just accepted higher
wages and fewer workers: if this meant higher unemployment then so be it
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54 -> 47 hrs
redistributes in favour of labour, which means employers are less happy to hire: thus unemployment, but if a 47 hr
workweek contract becomes standard it’s very hard to revert it
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(26) Graph
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Real wages are even higher in the 1930s, however, but plateau
and in fact even shrink- the jobs that are protected have good wages, which can’t be lowered because of contracts
(27) Reason 3: Real wage too high
Productivity relative to W/P did improve in the 1920s
Firms fired the least productive workers, who were then unable to price themselves back into work
These long term unemployed then became ‘outsiders’ in the labour market
Unionized ‘insiders’ set industry wages, to the disadvantage of ‘outsiders’
As a result, natural rate of unemployment remained high
Unemployment Reason 2
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The least productive workers go into the unemployment pool, one of
the reasons why employers may look dubious about hiring unemployed people
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Political and social reasons prevent Walrusian mechanisms of
employment clearing, where better paid workers would take pay cuts to fund employment of others
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You get unto a natural rate of 8% (high) and demand fluctuations cause this the
oscillate, at least unto the Great Depression
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), there is also deflationary policy as well as the Great Depression
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Crafts goes after Benjamin & Kochin by suggesting that their view is
inconsistent with how the labour market is actually functioning
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Microeconomic factors
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Benefits are introduced in the
interwar period and this creates a disincentive for workers to work
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What we need is a view which made sense a the micro level,
which tells us something about the macro story:
(30) Microeconomic factors
Eichengreen: uses microsurvey data from the ‘New Survey of London Life and Labour’ conducted by the LSE, starting in
1928
Sequel to Charles Booth’s (1899-1903) study of social and economic conditions of working class in late Victorian
London
Microeconomic factors
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(31) Microeconomic factors: Eichengreen
Interviewers collected data on earnings (or earnings in a normal week if you were unemployed) and variety of other
characteristics,
Respondents were distinguished between household-head and non-household-heads earnings
Microeconomic factors
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(32) Microeconomic factors: Eichengreen: Results
Unemployment rate was 8
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Eichengreen find unemployment rate is 8
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You are more likely to be hired if you are a perceived
bread inner in this time
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When you look at this viewpoint that “it’s benefits what did it”, it doesn’t really hold up that well
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(33) Microeconomic factors: Crafts
Group of long term unemployed workers emerged during 1930s, which is difficult to reconcile with ‘search’ model of
unemployment that underpins B&K approach
In search model: longer you search → gains from further search fall → more likely to accept job offer and re-enter
employment
Microeconomic factors: Crafts
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(34) Microeconomic factors: Crafts
Crafts’ review of microeconomic data reveals that the longer you are unemployed, the less likely you are to re-enter
employment
Transitional unemployment becomes structural unemployment
Microeconomic factors: Crafts
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)
(35)
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Demand management: exchange rate and tariff
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(36) Return to the Gold Standard
Literature centres round formal return to gold in 1925
Key questions asked are:
Was there any alternative?
What was scale of over-valuation in 1925?
What were the effects of over-valuation of sterling during 1925-31?
Gold standard
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Here’s where a lot of the policy questions pop up
- the biggest question being about the gold standard: this idea that currency should be based on something tangible that people should be allowed to trust their money, it should mean something
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It is then assumed that they will re-enter: but
when and on what terms?
They re-enter in 1925 in a bad economic policy decision
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(37) Was there any alternative?
The establishment were united behind the decision to return to Au so there wasn’t much alternative for the
government
There were, however, significant minority dissents from this view
Pollard argues authorities at fault in believing that bankers were the best judges of monetary policy in a capitalist society
Was there any alternative? Returning to gold was seen as a key part of bringing back pre-war prosperity
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Pollard argued that policymakers were far too
appeasing to banking interests
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But having a gold standard was in their interest- it made banking easy
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(38) Scale of Overvaluation in 1925
Consider £ against 5 major currencies ($US, FF, German mark, Italian lire and Japanese yen)
Also consider currencies weighted by their importance in UK trade
Although £-$ exchange rate declined, £ versus other European currencies rose
Because other Euro countries suffered even higher inflation than UK, and hence depreciated against Au by even more
ER and tariffs: Scale of overvaluation
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Went back on gold at an overvalued
rate
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The £/$ ER does decline - because $ is
strengthening during this period
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That hurts Britain in these
European markets, just as they need them to restore economic growth
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(39) What were the effects of over-valuation?
Moggridge: uses an elasticities approach to calculate the effects of an 11% appreciation of £ from its 1924 level
Makes assumptions about:
Exporter reduced profits
Importer increased profits
Elasticity of D
The effects of over-valuation: So, Moggridge has tried using various elasticities to calculate what would have happened
as a result of an 11% appreciation, (which is what happened after they went back on in 1924
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(40) Using these assumptions, Moggridge finds that exchange rate appreciation caused worsening of visible trade
balance by £64 million
Combined with deterioration of invisible trade balance of £16 million
Overall deterioration on current account of £80 million
The effects of over-valuation
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(64m is visible, 16m is after/ indirect effects
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(41) Exchange rate policy was an important factor in explaining fluctuations of unemployment around the natural rate
Unemployment increased immediately after adoption of tight money policy in 1919
Exchange rate appreciation during 1920-21 had a dramatic effect on unemployment
The effects of over-valuation
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There has been too much inflation, the pound is too devalued- and you see the effect in
unemployment
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(42) Floating £ and tariffs in 1930s: floating £
Britain forced off gold in Sept 1931 during major international financial crisis that started in Central Europe
Accominotti: Merchant banks exposed to counterparty risk from bankers’ drafts from trade with Germany
Sudden stop of capital flows leads to a run on the Bank of England, forcing Britain to abandon convertibility
Floating £ and tariffs in 1930s
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In September 1931, there is a
financial crisis which breaks out all over Europe, starting centrally with Creditanstalt in Austria and then spreads very
rapidly
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Accominotti had found the channel
by which Britain gets forced to abandon the Gold Standard (to devalue its currency), which is: Britain is doing lots of
trading with Germany in this period, and as soon as that trade is cut off by Germany stopping all capital exports - all
those counter parties (of those German merchants) who have guaranteed their contracts, suddenly find themselves
short
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The British counter parties don’t
have the money and have someone really eager to get paid on their end, and so they go to the BoE for emergency
funds
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The BoE is worried about paying up, and so they break the link with gold
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(43) Floating £ and tariffs in 1930s: floating £
Freed from the constraints of maintaining gold parity, Britain adopted looser monetary policy
Allowed exchange rate to float downwards
End of the interwar gold standard
Britain leaves relatively early (1931)
Timing of recovery across countries correlated with leaving gold, adopting loose monetary policy
Floating £ and tariffs in 1930s: floating £
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This is
fortuitous, because leaving the Gold Standard early is correlated with pulling out of the Great Depression
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Eichengreen’s book ‘Gold Fetters’ describes just how
bad it was to stay on gold because you couldn’t devalue your currency
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They will arbitrage the heck out of your CB and you’ll have to go on gold anyway
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After the decision to float there was some attempt to offset some of these
effects by raising tariffs to protect domestic industry
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There’s some ambiguous effect here, it’s clear the
government were not thinking of this in the same way we were
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And so, to some extent the increase in tariffs offsets some of the gain that Britain would have seen from going off
gold
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(45) Floating £ and tariffs in 1930s: summary
Interactions between exchange rate and tariff make it difficult to compare impacts
Findings of Broadberry, Morridge, etc, is that the exchange rate depreciation was a much more powerful boost to the
economy than policy
Floating £ and tariffs in 1930s: Summary
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Broadberry, Morridge, etc have found that it’s the
monetary channel that really matters
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Monetary orthodoxy: when times are bad devalue the currency to reduce exports
and increase growth
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(46)
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Demand management: domestic monetary and fiscal policy
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(47) Middleton (2010): In Britain (and most countries) fiscal policy was not used
Low public infrastructure spending, balanced budgets
Keynes proposed public spending in 1933
Serious political obstacles, questions about debt sustainability prevented large-scale spending
Likely would have been effective
Hatton suggests multipliers of 1
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75
Broadberrry suggests 1
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5
Domestic MP and FP
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Middleton says, it didn’t work - not because there anything
wrong with the idea - but because they didn’t do it
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Keynes suggested that maybe you might be able to get people back working by spending, but the government ignored
it - they kept budgets balanced, infrastructure spending fairly low - this was not a period of deficit spending
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2 - 2
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There is thus evidence that the
government could have done something, but didn’t
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(48) Exchange rate
Deflationary monetary policy of 1920s had a negative effect on output
Sharp rise in exchange rate during 1920-21
Reduced competitiveness of British industry
Expansionary monetary policy of 1930s had a positive effect on output
Leaving gold and pursuing independent monetary policies (i
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cheap money)
Exchange Rate
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In the 1920s they try very hard to get back on the gold
standard
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This interest rate
hike is being pursued by the government, for policy reasons, not to help out business, which makes them less
competitive in a time where it needs to be competitive
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These are the two big factors which push Britain down in the 1920s and up in
the 1930s
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Howson has emphasised the big effect of monetary expansion in the 1930s is seen through a housing
boom
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There’s a lot
of scope for secondary earners to own houses
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Regulations are dropped, new houses are built and this is one of the main things that pulls Britain out of
Depression and keeps it at ‘mild’ rather than ‘severe’
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(50) Broadberry claims that Howson overstates the importance of the housing boom
Claims there is no evidence provided on interest elasticity of investment in housing, and that there are other possible
explanations for the housing boom
Other important factors:
Rising real incomes
Falling building costs
Demographic factors
The role of building societies…
Housing boom
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He claims there is no evidence it it just housing: there are other things that might be helping Britain to recover from the
Depression: real incomes are going up, building costs are falling, demographic factors (households are slowly changing)
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(51) Role of building societies
Humphries stresses the importance of the emergence of competition among building societies
Might be expected that cheap money caused housing boom because fall in interest rates led to an increase in demand
for mortgages
However, building societies were often slow to decrease mortgage rates following BoE adjustments
…
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Humphries has looked at these building societies that underwrite mortgages - these are the
financial intermediaries that run the housing market in Britain in this period
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Building societies try really hard
to build more houses, underwrite more loans, push more money out the door
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So, this is one channel for how
interest rates end up in economic recovery
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Role of building societies
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How it is exactly that building societies managed to finance all of
this if they weren’t adjusting their prices as quickly as the BoE would like
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Idea of societies
holding mostly mortgages, lowering their capital, increasing their leverage, taking more risk were associated with
recovery from the Great Depression in Britain
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So, they start competing with each other: they used to be cartelised (profits were made from cooperation rather than a
big housing boom), but as soon as ir start dropping, they start competing with each other
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Inflation of the housing market not a bad thing: economic growth is low,
unemployment is really high, housing prices have dropped, so what you really want is to reinvigorate that market, and if
you start setting low ir, building societies see an opportunity: they start competing with each other, they build more
houses, people go to work in the construction sector, now they have wages…
Supply and demand both increase because credit increases
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In general nothing happens - Middleton is right - markets stay balanced
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There are aspects of fiscal policy that do actually change during this time, however
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(54) Fiscal policy: Yellow Book programme
Liberals in 1929 proposed “Yellow Book” programme of public works
Proposed to increase public spending by £100 million for 3 years
Fiscal policy: Yellow Book programme
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And they have this yellow book programme as which advocates the construction of (bridges, infrastructure) - ‘shovel
ready projects’ with the idea to increase public spending by £100m a year, for 3 years
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5 in long run
Estimates reduction in unemployment at only 359,000 by 1933, on a total of 3,100,000
Broadberry (1986): claims that even 11% may be too optimistic
Fiscal policy: Yellow Book programme
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This would not have solved Britain’s woes,
but it might have made them a little better
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Although, by
modern standards this would not have been an enormous Keynesian programme
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(56) Rearmament
Lloyd George fiscal schemes proposed to increase government spending during early 1930s
During later 1930s, in fact, such an increase in government spending actually took place as a result of rearmament
Thomas assesses role of government spending on rearmament in the recovery of 1930s…
Rearmament
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You have, in the mid 1930s, an increase in defence spending led
by David Lloyd George (DLG), who proposes to re-arm Britain and respond to the increasing threats on the continent
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(57) Annual spending on rearmament increased from
£103m in 1932/33 to
£400m by 1938/39
Big rise dates from 1935, when war with Germany was a serious threat
Sectors that benefited most from direct spending were: shipbuilding, engineering, aircraft, construction
Largest proportion of increased employment is in engineering
Rearmament
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In 1935 it was clear that Europe would not remain demilitarised and Hitler was rearming Germany; Russia’s
winter war
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This is prominent in
heavy industry sectors like shipbuilding, aircraft, etc
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5-0
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Interestingly, Craft and Mills’s recent research, which relies on defence news as an exogenous shock,
calculate what the multiplier would have been, has said that in early 1930s multipliers on defence spending weren’t
actually that great
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0
...
8% means
you would be losing money if you taxed £1 out of the economy and spent it on defence
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After
1935 the government commits, not just to spending in response to short term shock, but in the LR commits large
chunks of money (£400m) a year
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The SR stimulus is not all that effective but the
rearmament programme does have a large effect on the economy and does start to pull Britain out of the Depression,
reduce unemployment, increase GDP (although this is not consumer goods, just tanks etc
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What was happening in 20s/30s in the interwar? Macro invented in 1930s by scholar thinking about these
structural unemployment problems for the first time
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Govt did try and do
some things about this, but this is not a benefits laziness story
...

(61) Negative shocks to AD raised unemployment above this level
Particularly with Great Depression of early 1930s
Exchange rate policy also played important role, with return to gold in 1920s exacerbating situation
And policy of floating in 1930s allowing more reflationary policy stance
Although, be careful not to overstate the contribution of cheap money
Conclusions
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There are other things
than cheap money involved here: there is also rearmament spending; policy changes to allowing housing to be built
(regulation is amended); competition among building societies matters: there wouldn’t have been a boom if the cartel
had held firm and just used the cheap money to brook customers
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