Explain how exchange rate policies affected economies during the Great Depression

Question

What will be an ideal response?

Answer 1

Many countries were on the gold standard at the beginning of the Great Depression. A gold standard requires that monetary authorities keep the stock of money in a constant ratio relative to the stock of monetary gold that the nation holds. This restricts the ability of a nation to use monetary policy. In 1931, it was widely expected that the United Kingdom would leave the gold standard altogether, and speculation turned against the pound. In September 1931, Britain left the gold standard and speculators immediately shifted their attention to the dollar. Expecting a similar decline in the value of the dollar, they began to sell dollars and dollar denominated assets, all of which resulted in gold outflows. The Fed was forced to respond by raising interest rates, and thus the U.S. economy continued its downward spiral. Countries that left the gold standard more quickly were able to use expansionary monetary policy sooner, and thus they recovered more rapidly. The U.S. did not leave the gold standard until after Roosevelt's election, and after that point, the economy began its recovery.