Uncertainty and the Great Slump

by Jason Lennard (London School of Economics and Lund University)

This article is due to be published in the Economic History Review and will be available on Early View later in the year.

 

Holland House library after an air raid
Holland House library after an air raid, 1940. Available at Wikimedia Commons.

A key challenge in economic history is to understand the macroeconomics of interwar Britain. This was a time of high unemployment, depressed economic activity and significant macroeconomic volatility. Economic historians have identified a number of causes, from the demise of the old staple industries to the shortening of the working week (Richardson, 1965; Broadberry, 1986).

Yet the historiography has not explored an important source of modern economic fluctuations: uncertainty (Bloom, 2009; Jurado et al., 2015; Baker et al., 2016). A fog of uncertainty may well have hung over Britain between the wars given the volume of extraordinary events. Economically, there was the return to and break from the gold standard, the fiscal aftermath of the First World War and the slide to protection. Politically, there were snap general elections in 1923 and 1931, hung parliaments following the elections of 1923 and 1929 and national governments during the 1930s.

In new research (Lennard, forthcoming EcHR), I investigated how economic policy uncertainty affected the British economy in the interwar period. As a nebulous concept, the first step was to measure uncertainty. In order to do so, I constructed an index based on the frequency of articles reporting uncertainty over economic policy in the Daily Mail, Guardian and The Times (Figure 1).

 

Figure 1. New economic policy uncertainty index for the United Kingdom, 1920-38 (average 1920-38 = 100)

Lennard 1
Source: as per original article.

 

The new index is plotted in Figure 1, which shows that there was significant variation in uncertainty in the United Kingdom between 1920 and 1938. Uncertainty spiked around recurring events in the calendar such as budget announcements and general elections but also in response to more specific factors such as the General Strike, looming inter-allied debt payments and changes in the likelihood of war.

The second step was to account for the macroeconomic effects of uncertainty. Using a vector autoregression, I found that uncertainty was associated with reduced credit (a ‘financial frictions effect’), fewer imports (a ‘magnification effect’), lost jobs, and lower economic activity. Overall, economic policy uncertainty accounted for more than 20 per cent of macroeconomic volatility.

A wealth of narrative evidence backs up the significance of uncertainty shocks. At the microeconomic level, there were regular reports of disruption to a number of industries from pianos to textiles. In the car industry, for example, Sir William Letts, chairman and managing director of Willys Overland Crossley, told shareholders at the annual general meeting that uncertainty is,  ‘crippling business and holding back activity and energy in our great industry’ (Guardian, 25 Feb. 1930, p. 6).

At the macroeconomic level, there were frequent descriptions of depressed employment and output. In 1920, for example, the Daily Mail (30 Dec. 1920, p. 4) reported that, ‘among the main causes of unemployment at the present moment […] is uncertainty in the business world’. In 1930 Sir William Morris wrote that Britain was ‘floundering in a sea of uncertainty […] the result being colossal unemployment’ (Daily Mail, 29 Aug. 1930, p. 8). In 1932 the Economist (30 Jan. 1932, p. 1) summarised that ‘business this year has been overshadowed by the economic and political uncertainty at home and abroad’.

In summary, uncertainty has been a forgotten, albeit incomplete, explanation for macroeconomic instability in interwar Britain. How uncertainty affected economies in other historical contexts is an important and open question for future research.

 

To contact the author:

Email: jason.lennard@ekh.lu.se

Twitter: @jason_lennard

 

References

Baker, S. R., Bloom, N., and Davis, S. J., ‘Measuring economic policy uncertainty’, Quarterly Journal of Economics, 131 (2016), pp. 1593–636.

Bloom, N., ‘The impact of uncertainty shocks’, Econometrica, 77 (2009), pp. 623–85.

Broadberry, S., The British economy between the wars: a macroeconomic survey (Oxford, 1986).

Jurado, K., Ludvigson, S. C., and Ng, S., ‘Measuring uncertainty’, American Economic Review, 105 (2015), pp. 1177–216.

Lennard, J., ‘Uncertainty and the Great Slump’, Economic History Review, (forthcoming).

Richardson, H. W., ‘Over-commitment in Britain before 1930’, Oxford Economic Papers, 17 (1965), pp. 237–62.

Military casualties and exchange rates during the First World War: did the Eastern Front matter?

by Pablo Duarte and Andreas Hoffmann (Leipzig University)

An article expanding on this blog has been published in the Economic History Review.

 

Russian_Troops_NGM-v31-p372
Russion troops going to the front. Available at Wikimedia Commons.

In 1918 the Entente forces defeated the Central Powers on the Western Front. The First World War, with countless brutal battles and over 40 million casualties, had finally ended.

During the war, all governments substantially increased their national debt and promised to hand the bill to the losers. They also promised to return to the pre-war gold parity rather than inflating and devaluing their currency. Since the outcome of the war was expected to severely affect currency values, particularly for the losers,  foreign exchange traders had an incentive to closely follow war events to update their beliefs on who was more likely to win.

According to Ferguson’s (1998) The Pity of War, the lost morale of the German troops — reflected in higher numbers of prisoners of war and of soldiers surrendering on the Western Front — was the ultimate reason for their defeat. Complementing this argument, Hall (2004) provided evidence that military casualties on the Western Front — the key front to finally winning the war — can help explain contemporary fluctuations in the exchange rates between belligerents’ currencies.

Although finally decided in the West, historians have emphasized the relevance of the global dimension of the First World War and the importance of the Eastern Front in understanding its complex evolution. Imagine it is 1914. Russia has just entered the war (earlier than expected), upsetting the plans of the Central Powers to circumvent a two-front war. Events on one front affected those on the other. But did contemporary traders, like historians today, consider the Eastern Front to be of relevance?

In our forthcoming article, we provide the first empirical insights into the relative importance of the Eastern Front during the First World War from the perspective of contemporary foreign exchange traders. Building on Hall’s study, the article indicates when and to what extent military casualties from both the Western and  Eastern Fronts were linked to exchange rate fluctuations during the First World War, and suggest that traders used this information as an indicator as to  which side was more likely to win.

To analyze the link between exchange rates and casualties we have introduced a novel dataset:  the German Reichsarchiv and the Austrian War Office. Merging our dataset with that for the Western Front employed by Hall (2004), we have been able to construct a rich dataset on war casualties for France, Britain, and Russia as well as Germany and Austria-Hungary, for  both Fronts.

 

Figure 1. 15,000 Russian Prisoners of war in Germany.

Duarte & Hoffmann
Russian prisoners in Germany. Available at Wikimedia Commons.

 

Using the digital archives of the Neue Zürcher Zeitung (a Swiss newspaper),  we have further documented information on casualties, specifically  the number of prisoners of war (Figure 1).  The following quote from December 1914 makes this finding explicit:

Berlin, Dec. 31 [1914] (Wolff. Authorized) The overall number of prisoners of war (no civilian prisoners) in Germany at the end of the year is 8,138 officers and 577,875 men. This number does not include a portion of those captured on the run in Russian Poland nor any of those still in transit. The overall number is comprised of the following: French 3,159 officers and 215,905 men, including 7 generals; Russians 3,575 officers and 306,294 men, including 3 generals; British 492 officers and 18,824 men (Neue Zürcher Zeitung, 1 Jan. 1915, p. A1.).

 

In summary, our forthcoming article provides evidence that foreign exchange traders recognized the global dimension of the war, especially the Eastern and Western Fronts.  Casualties on both Fronts were associated with exchange rate fluctuations. The number of soldiers captured on the Eastern Front affected exchange rates in the early war years. Foreign exchange traders gave additional weight to the Eastern Front during the first year of the war because Russia’s attack came as a surprise and the number of casualties was substantially higher than on the Western Front.

From autumn 1916 onwards, even though Russia had not yet left the war, our findings indicate that traders believed that the key to winning the war was in the west.  The Brusilov offensive, a massive Russian attack (from June to September 1916), had proven that the Central Powers would face substantial opposition in the East. Moreover, the Allied forces on the Western Front had started to coordinate joint offenses.

 

To contact the authors:

pablo.duarte@uni-leipzig.de Twitter: @economusiker

ahoffmann@wifa.uni-leipzig.de Twitter: @Andhoflei

 

References

Ferguson, N. (1998). The Pity of War. Basic Books.

Hall, G. J., ‘Exchange rates and casualties during the First World War’, Journal of Monetary Economics, 51 (2004), pp. 1711–42.