Kochin 1984; Barro 1986) who argue that short-term rates would decline at the
outbreak of war because of declines in future consumption.
To simplify our analysis, we assume a taxation scheme that preserves the incentives
of short-term investors to undertake second-period investment projects.
In a system in which liabilities consist of accounting entries, this would amount
to a capability of electronic invasion of the bookkeeping system. Moreover, adding a
cost of counterfeiting would require withdrawals from the banking system in the second
period to supply the government with resources to undertake counterfeiting. We ignore
this complexity here.
If either country were to anticipate the outbreak of the war in period 1, defensive
measures would be taken to insulate the economy against financial attacks. In this section
we abstract from these defensive measures and study the effects of financial warfare on
an unprotected economy. In the next-to-last section of this chapter, we consider defensive
financial warfare designed to immunize a nation from the effects of a financial attack.
We might assume that banks immune to further attack reemerge in period 3 or
that governments nationalize the capital markets, using centralized decision making to
protect the war mobilization from further financial attack.
A financial attack can be severe enough to preclude the future production of war
goods. To see this, recall from our discussion of peacetime versus wartime periods that
there exists a threshold endowment level below which no war occurs in the Nash equilibrium. If the financial attack drives an enemy's resources below this threshold level,
zero war expenditure emerges as the equilibrium outcome.
Backman J., ed. 1952. War and Defense Economics. New York: Rinehart and Co.
Barro Robert J. August 1986. "Government Spending, Interest Rates, Prices, and Budget
Deficits in the United Kingdom, 1701-1918." Cambridge: National Bureau of
Economic Research. Working Paper 2005.
Benjamin Daniel, and
Levis Kochin. 1984. "War, Prices, and Interest Rates: A Martial
Solution to Gibson's Paradox." In A Retrospective on the Classical Gold Standard,
Michael D. Bordo and
Anna J. Schwartz. Chicago: University
of Chicago Press.
Brown University Economists. 1942. Introduction to War Economics. Chicago: Richard
Chandler Lester V., and
David H. Wallace. 1951. Economic Mobilization and Stabilization. New York: Henry Holt and Co.
Diamond Douglas, and
Phillips Dybvig. 1983. "Bank Runs, Deposit Insurance, and
Liquidity." Journal of Political Economy 91, no. 3: 401-19.
Hall Robert E. 1989. "Consumption." In Modern Business Cycle Theory, ed.
Robert J. Barro
. Cambridge: Harvard University Press.
Hammond Bray. 1970. Sovereignty and an Empty Purse. Princeton, N.J.: Princeton
Harris Seymour. 1930. The Assignats. Cambridge: Harvard University Press.
Laughlin W. Laurence. 1918. Credit of the Nations. New York: C. Scribner's Sons.
Lucas Robert, and
Nancy Stokey. July 1983. "Optimal Fiscal and Monetary Policy in
an Economy without Capital." Journal of Monetary Economics.