Britain Return To Gold In 1925
Economic History
The Gold Standard, like the Exchange Rate Mechanism, ensures stable exchanges and economic discipline. Why, then, was there so many criticism of the return to gold in 1925?
In March 1919, the large trade deficit and low level of gold reserves resulted in formal abandonment of the gold stand by the UK. On Apr. 28, 1925, Churchill announced in his Budget speech that there would be an immediate return to gold at pre-1913 parity.
Reddaway (Lloyds Bank Review, 1970) expresses in his article that returning to gold at $4.76 was a failure of the committee that they had not done enough research and had not have enough consideration and look at other countries apart from the US. The committee failed to take account of prices in any external country apart from USA and also used the wrong indices (wholesale price) for their calculation and hence derived the wrong result.
The policy announcement in 1919 of the intention of returning to pre-1913 gold standard was equivalent to the announcement of a contractionary monetary policy. Under flexible ER regime of 1919-1925 contractionary monetary policy is expected to result in an appreciating of nominal ER, deflate the price level (given high rate of inflation after the First World War) and improving competitiveness. However, because the ER is determined in an asset market that adjust relatively quickly, we would expect to observe an appreciation of the real ER in the short-run whereby the ER deviates from the PPP equilibrium.
According to Keynes' The Economic Consequences of Mr Churchill, when UK returns to gold in 1925, sterling was 10% overvalued. To determine the magnitude of overvaluation Keynes used purchasing power parity theory (PPP) which state that flexible exchange rate reflects movements in relative prices between countries.
Matthews argue that exchange rate was not overvalued and exchange rate in 1925 reflected more forces of economics fundamental than government intervention. This is due to...
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