When France climbed the fiscal cliff, in 1926

Paul Krugman presents a chart of UK and France growth and public debt (as share of GDP) relative performance in the 1920s. The charts show that using 1913 as a common base, France appears to have overtaken the UK in real GDP by the early 1920s, and its debt ratio went lower than the UK in 1926. Keep a note of that year. For Prof. Krugman, the message is clear —

So virtue was not rewarded, and French political weakness [devaluation and inflation] actually led to a better economic performance.

This conclusion is certainly consistent with the most recent IMF World Economic Outlook, which noted the inability of the UK to lower public debt in the 1920s. But at least for those of a certain age, references to French economic policies of the 1920s should ring a bell, back to a time when the so-called freshwater economists were paying a lot of attention to economic history and specifically the apparent monetarist stabilizations following World War I. 

The interesting and provocative work was provided by Thomas Sargent, who compared the famous Poincaré stabilization of 1926 (that year again) with what was envisaged (at his time of writing) by Maggie Thatcher. His key point was that a rapid change in price and wage expectations could be achieved by a monetary policy based stabilization, but only if there was a supportive fiscal contraction that laid to rest expectations of inflationary financing of budget deficits. France had a strange fiscal policy in the first half of the 1920s, with high public spending undertaken in the belief that German reparations would pay for it. When it became clear that it would not, the country entered a political struggle over the mix of tax increases, spending cuts, and devaluation of legacy debts that would restore the public finances to sustainability. The 1926 stabilization went for elements of the first two, and while of course benefitting from the franc devaluation in the years preceding it, actually resulted in a stronger franc through the positive expectations effects.

And it’s not just rational expectations people who think something like that happened. In a 1986 paper, Barry Eichengreen and Charles Wyplosz — economists who’ve done some things since then — wrote:

[Our] model suggests that the strong growth of [French] domestic investment after 1926 can be attributed to the ‘crowding-in’ effects of French fiscal policy. Growing budget surpluses made an increasing proportion of domestic savings available to private investors. The consistent growth of the French economy in the 1920s was not export-led, but investment-led, and a vital stimulus to expansion was provided by fiscal policy. This analysis may have some relevance to present-day experiences of fiscal stabilization […]

In other words, France in 1926 looks like an example of that elusive species, the expansionary fiscal contraction. Even if you don’t want to go that far, it certainly looks like other episodes of heterodox debt stabilization, such as Ireland in 1986, with a mixture of past exchange rate depreciation but also a critical element of, yes, austerity, that seems to convince people that the worst is over.

In any event, it’s not really fair to stop the interwar France-UK growth comparison in 1929. France rode its restored faith in a strong exchange rate through the first phase of the Great Depression, but then was in the last group of countries to let go, and paid a price in lost output as a result. By contrast, the UK’s more responsive political system saw that the game was up for Gold Standard, and devalued much sooner. A country can do well for a decade, and draw all the wrong lessons for the next one. Ask Ireland.

UPDATE: Matthew O’Brien at The Atlantic does a nice job of explaining the UK-France role reversal between the two decades. But he doesn’t note the fiscal stabilization aspect of France’s 1926 turnaround.

5 thoughts on “When France climbed the fiscal cliff, in 1926

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  4. “By contrast, the UK’s more responsive political system saw that the game was up for Gold Standard, and devalued much sooner.”

    Yes, that’s clear, and I have often made this argument myself. But I have also learned that it’s more complicated than devaluation versus no devaluation. For example, when the UK left the ERM, a thing that “everyone knows” is that it began a period of strong growth.

    But Italy left the ERM at the same time and devalued by about the same amount, but didn’t get back to the same growth path as the UK. In fact, Italy’s GDP has gone from being a bit bigger than the UK’s to being about 15% smaller.

    My conclusion is that the real benefit of devaluation is its interaction with other economic factors. In the UK, Maggie’s reforms were still working through the economy, while Italy has reformed to a much lesser extent. So the devaluation that worked for the UK, by sparking off a strong export-led recovery, did not work to nearly the same extent for Italy.

  5. “France appears to have overtaken the UK in real GDP by the early 1920s”

    Err, no, France grew by more, but France started off poorer. Before WWII there was a large disparity between GDP per capita in Britain and the rest of Europe, as today there is between the US and Britain. So we would expect France to grow faster even with equally good institutions as per conditional convergence. It should also be pointed out that France’s initial large dip is likely to have something to do with Germany occupying and devastating the Eastern part of the country, something that did not happen to Britain, and so the recovery cannot reasonably be ascribed to macroeconomic policies.

    Krugman probably knows both things but deliberately presented the data in a manner that is misleading to his readers, who are almost all less intelligent and knowledgeable than him.

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