Study Shows Recovery from the Great Depression Linked to Abandoning Gold Standard

The Great Depression of the 1930s marked one of the darkest chapters in global economic history. As nations grappled with widespread unemployment, economic stagnation, and financial turmoil, policymakers sought solutions to reverse the devastating effects. At the time, many countries adhered to the gold standard, linking their currencies to a fixed quantity of gold.

How was the Great Depression solved?

According to the study “The Ends of 27 Big Depressions,” by Martin Ellison, Sang Seok Lee, and Kevin Hjortshøj O’Rourke, there is compelling evidence suggesting that countries’ decisions to abandon the gold standard played a pivotal role in their recovery from the depths of the Great Depression. This study analyses data from 27 countries across 27 depressions between 1873 and 1991.

The gold standard, while providing stability in normal economic times, presented significant challenges during the Great Depression. The fixed exchange rates and restrictions on monetary policies constrained countries’ abilities to implement necessary measures to counter the economic downturn. The decision to abandon the gold standard, while controversial at the time, allowed nations the flexibility needed to recover from the Great Depression.

Take the contrasting cases of Finland and Norway during the Great Depression. Both struggled, but their respective adherence to and abandonment of the gold standard painted two starkly different pictures. Finland, clinging to the gold standard, sank deeper into the deflationary quagmire, witnessing plummeting output and unemployment. Norway, however, chose to break free in 1931. This allowed them to devalue their currency, stimulating exports and igniting an inflationary burst that spurred demand and investment, setting the stage for a faster and more robust recovery.

How did abandoning the gold standard benefit the economy?

The flexibility gained by abandoning the gold standard allowed nations to pursue expansionary monetary policies, such as currency devaluation and interest rate adjustments, which proved crucial in jumpstarting economic activity. Countries that remained tied to the gold standard faced limitations in their ability to respond effectively to the economic crisis.

Under the gold standard, central banks lose much of their ability to influence interest rates, a key tool for managing economic cycles. This inflexibility could leave economies vulnerable to shocks, hindering their ability to respond effectively to crises like recessions or financial bubbles. The current economic slowdown, characterized by rising interest rates and inflation, could potentially become a prolonged saga in a gold-backed system, with limited options for intervention.

While highlighting the significant roles of inflation expectations and departing from the gold standard, the study acknowledges the intricate effect of variables influencing economic recovery. Fiscal policy, social safety nets, and international cooperation all play crucial parts. Additionally, relying solely on inflationary expectations and disregarding potential drawbacks would be imprudent. Uncontrolled inflation can erode purchasing power and destabilize economies.

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