What caused the recovery from the British Great Depression? A leading explanation – the ‘expectations channel’ – suggests that a shift in expected inflation lowered real interest rates and stimulated consumption and investment. However, few studies have measured, or tested the economic consequences of, inflation expectations
Economic policy has been seen as a necessary feature to escape from the forces of falling prices and output during the Great Depression. In particular, the break from the gold standard in the early 1930s changed the policy trilemma faced by policymakers, allowing the potential use of discretionary monetary policy to respond to the depression.
One aspect of this is the idea that a policy regime change was necessary to end the depression path of the early 1930s. Temin defines a policy regime as ‘an abstraction from a single decision; it represents the systematic and predictable part of all decisions.’ A policy regime change implies a shift in expectations, and in the circumstances of the Great Depression, this meant the substitution of inflationary expectations to end the deflationary vortex.
According to Crafts, breaking away from the gold standard, implementing the ‘cheap money’ policy, imposing the General Tariff, and announcing an informal price-level target created a consistent policy framework, raising inflation expectations, lowering real interest rates, and stimulating expenditure. Crafts’s historical description implies that the sequencing of policy announcements may have contributed to the formation of a new policy regime in the United Kingdom. Measuring inflation expectations will help in evaluating the time profile of how policy regime change arose in the United Kingdom during the 1930s.
In this paper, LSE Department of Economic History Assistant Professor Jason Lennard and co-authors collect high-frequency information from primary and secondary sources to measure expected inflation in the United Kingdom between the wars. A high-frequency vector autoregression suggests that inflation expectations were an important source of the early stages of economic recovery in interwar Britain.
Read the full article in full here: Lennard, Jason, Meinecke, Finn and Solomou, Solomos (2022) Measuring inflation expectations in interwar Britain. Economic History Review. ISSN 0013-0117
