Monetary Sovereignty, Exchange Rates, and Capital Controls: The Trilemma in the Interwar period

Maurice Obstfeld, Jay C. Shambaugh, Alan M. Taylor

NBER Working Paper No. 10393
Issued in March 2004
NBER Program(s):International Finance and Macroeconomics, Monetary Economics

The interwar period was marked by the end of the classical gold standard regime and new levels of macroeconomic disorder in the world economy. The interwar disorder often is linked to policies inconsistent with the constraint of the open-economy trilemma the inability of policymakers simultaneously to pursue a fixed exchange rate, open capital markets, and autonomous monetary policy. The first two objectives were linchpins of the pre-1914 order. As increasingly democratic polities faced pressures to engage in domestic macroeconomic management, however, either currency pegs or freedom of capital movements had to yield. This historical analytic narrative is compelling with significant ramifications for today's world, if true but empirically controversial. We apply theory and empirics to the interwar data and find strong support for the logic of the trilemma. Thus, an inability to pursue consistent policies in a rapidly changing political and economic environment appears central to an understanding of the interwar crises, and the same constraints still apply today.

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Document Object Identifier (DOI): 10.3386/w10393

Published: Obstfeld, Maurice, Jay C. Shambaugh and Alan M. Taylor. "Monetary Sovereignty, Exchange Rates, and Capital Controls: The Trilemma in the Interwar Period." IMF Staff Papers 51 (2004): 75-108. citation courtesy of

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