The Bank of England Needs to Look Back - and Think the Unthinkable
King, Stephen, The Independent (London, England)
On 24 October 1930, a report from the British government's Economic Advisory Council was circulated by Ramsay MacDonald, the Prime Minister, to his Cabinet. The Economic Advisory Council consisted of the great and the good of the economics profession, and was chaired by John Maynard Keynes. Its terms of reference were "to review the present economic condition of Great Britain, to examine the causes ... and to indicate the conditions of recovery."
Note the date. This was a year after the Wall Street Crash, a year in which the world had succumbed to a deep recession. The Depression, though, was still to come. The US economy had fallen off a cliff in 1930, but most of the economic losses occurred in 1931 and 1932. The UK economy was only in the early stages of its own downturn. The now-famous Jarrow march didn't take place until 1936.
The Council was particularly worried that the sustained declines in commodity prices of the late 1920s might pave the way for a more generalised decline in prices. The members were vexed by the impact of a falling price level on the government debt burden (which, in real terms, was in danger of rising). They were troubled by the statutory payments to pensioners and to the unemployed which, in a world of falling prices, would become more expensive in real terms. And, in particular, they were worried about social resistance to wage declines.
Their conclusions proved remarkably accurate: "The result of all this is that money costs ... are out of line with money prices. Consequently, producers lose money; they are unable to maintain their former labour forces; and unemployment ensues on a colossal scale." As an economic forecast, that takes some beating. The British government was given due warning in the very early stages of the global Depression that bad news was on its way. It was also offered advice on what to do to minimise the risk. The Council wanted to see a significant easing of monetary policy. However, under the Gold Standard there was little room for flexibility: "The Bank of England cannot, under current gold standard limitations, move far in this direction unless other central banks do the same." The Council was mostly worried about the US Federal Reserve, which was apparently in no mood to go down the road of cheap credit. And ultimately, Keynes and his colleagues were held hostage by the prevailing conventional wisdom: "It is quite a different matter today to go back on the decision then made [the 1925 return to the Gold Standard]. We think there would be grave objections to such a course, because of its reactions on our international credit ..."
Two conclusions stem from all this. First, policymakers had plenty of warning about what was going to hit them. Second, the warnings weren't immediately acted upon - either because the remedies weren't seen to be credible or, alternatively, because they were deemed unacceptable in an international context.
A year later, the UK did leave the Gold Standard. History is kind in its treatment of this apparently cataclysmic event. Britain's departure, after all, provided a cushion for the economy at a time when the rest of the world was plunging into economic despair. The UK's downswing was, in the event, a much more modest affair than America's. However, this didn't stop the UK Government defaulting on its First World War debt in 1932, leaving many domestic investors worse off. Nor did it stop those Jarrow marchers. The UK's relative out-performance still left the economy on its knees for much of the decade. …