Economic lessons of the 20-year armistice

by John Q on February 18, 2021

Another extract from my book-in-progress, Economic Consequences of the Pandemic

The 20-year armistice from 1919 to 1939 was a period of economic stagnation in Europe, punctuated by crises which had disastrous economic and political effects. And while the US boomed in the 1920s, the Great Depression that began in 1929 caused massive unemployment and suffering which lasted through the 1930s. What lessons can we learn for the present?

The most important is the danger of ‘austerity’ policies based on the perceived need for governments to balance budgets and ‘tighten their belts’. Keynes’ second great polemic, The Economic Consequences of Mr Churchill was a critique of the austerity policies of Winston Churchill, then Chancellor of the Exchequer (equivalent to Treasury Secretary) in the Conservative government of Stanley Baldwin.

Churchill’s critical mistake was made in 1925 when he announced that Britain’s return to the gold standard. Before the outbreak of the Great War, both the British pound and the US dollar had been convertible to gold at fixed rates, such that one pound sterling was worth $4.86. By imposing exchange controls when war broke out, Britain effectively ended convertibility and left the gold standard.

Churchill’s decision restored the pre-war exchange rate, even though the price level in Britain had risen substantially faster than in the US. This implied the need for a sharp deflation, driven by budget cuts and credit restrictions. The inevitable outcome was an increase in unemployment rates. Churchill’s decision was the culmination of a long period of austerity policies aimed at driving down price levels, which had already pushed the rate of unemployment towards 10 per cent. Unemployment remained at or above this level until the return to war in 1939, at which point it vanished almost instantly.

Churchill’s policies were disastrous, but the damage was mostly limited to Britain. Far worse in its consequences was the austerity policy adopted by Heinrich Bruning, the Chancellor of Germany from 1930 to 1932 in response to the Great Depression. The resulting upsurge in unemployment produced massive social discontent. Bruning was forced from office and replaced, after a brief interval, by Adolf Hitler. Repudiating Bruning’s austerity policies, Hitler adopted a policy of large scale spending on public works and military expansion which greatly reduced unemployment. This success increased his popularity and allowed him to crush his opponents without significant resistance.

These examples are the rule rather than the exception. Austerity policies have almost invariably failed as a response to depression and unemployment. Further examples ….

Despite its disastrous consequences, Bruning’s austerity policies have been forgotten almost entirely. The same can’t be said of the German hyperinflation of 1923 (discussed in detail later). The Imperial German government had relied heavily on inflation and debt to finance the war, relying on the spoils it expected to seize to resolve its problems. Instead, its democratic successor inherited high levels of debt and continuing inflation, along with the reparations imposed under Versailles. When the government tried to support striking workers in the French-occupied Ruhr valley and acquire gold to pay reparations at the same time, it had no tax revenue to cover the costs. Instead it relied on printing money which depreciated rapidly.

The hyperinflation caused less suffering than the Great Depression. Nevertheless, it wiped out the savings of millions of people and contributed both to radicalisation and to the embrace of austerity policies in Germany, not only in the 1930s, but right down to the present day.

There’s no serious prospect of inflation now, and there won’t be for years to come. But that doesn’t mean that it’s safe to rely on money creation rather than taxation to finance large new public spending programs. It took ten years for the German mark to go from gold-backed hard currency to worthless paper. The process could have been stopped earlier. But, as we learned in the 1970s and 1980s, squeezing inflation out of a system is a painful process.

To sum up, we can draw two lessons from the economic failures of the 20-year armistice.

First and most importantly, market economies do not automatically tend towards full employment . Governments must be willing to fill the gap when private consumption and investment expenditure is inadequate. Conversely, in the rarer case when private demand is excessive, governments and central banks must act to constrain demand to a level consistent with the productive capacity of the economy.

Second, the ordinary operations of government require resources that must, in the end, be supplied by taxation. Attempting to deliver substantially increased public expenditure while leaving private expenditure untouched will run up against the constraints imposed by the productive capacity of the economy. These constraints will initially be reflected in shortages, queues and reduced quality and ultimately inflation.



Rapier 02.18.21 at 12:28 pm

To just label England’s post WWI economic policies as “austerity” while ignoring the mechanisms of England’s monetary/financial system under the Bank of England and the theoretical underpinnings of that Central Banking system is a profoundly blinkered way of looking at the world.

On the other hand the world has seen a profound revolution in money, it’s total amount globally growing at ever accelerating rates since 1980.

1986 to 2016

up to mid 2020

An approximate 900% increase in the amount of money globally in the last 35 years has engendered an entire army eager to throw themselves into battle against “austerity”. Go figure. Most of who cannot actually say what money is or where it comes from. As if it is some emergent phenomena that is at the same time managed by policy. I’d say go figure again but there is no figuring.


John Quiggin 02.18.21 at 7:29 pm

A 900 per cent increase in money is not particularly surprising, given that the money value of world output has risen by about 500 per cent in that time, and inflation is lower.


MisterMr 02.18.21 at 8:57 pm

I think the idea that the current german fixation against inflation is due to memories of hyperinflation in the interwar period is a red herring.

The problem from Germany’s point of view is that there are many countries in easter Europe with a significantly lower income level that might easily take its place in manifacturing, so it has to keep wages low (relative to productivity) to avoid this, while high exports mean that Germany doesn’t need to stimulate internal demand that much.

Also, inflation has nothing to do with the quantity of money, which is mostly endogenous.


J-D 02.19.21 at 2:19 am

An approximate 900% increase in the amount of money globally in the last 35 years has engendered an entire army eager to throw themselves into battle against “austerity”. Go figure. Most of who cannot actually say what money is or where it comes from. As if it is some emergent phenomena that is at the same time managed by policy. I’d say go figure again but there is no figuring.

You perceive the following sequence of events:
1. The amount of money increases 90%.
2. People declare their opposition to austerity policies.

I perceive the following sequence of events:
1. Advocacy of and/or implementation of austerity policies by governments increases.
2. People declare their opposition to austerity policies.

Your perception is puzzling. Mine is not puzzling.


Robespierre 02.19.21 at 9:08 am

even taking your figure as good, that translates to less than 7% yearly.
World population alone increased at least 1.5% per year during that period. Add at least 2-3% real gdp per capita growth just to have the tiniest amount of catch-up to the USA. You now have 3.5-4.5% real growth, leaving you with 2.5%-3.5% inflation.

The horror!


nastywoman 02.19.21 at 11:35 am

and this thread proves that ”them Anglos” NEVER will understand ”them Germans” –
as ”them Anglos” –
somehow? –
always think that ”them Germans” want ”austerity” – ”due to memories of hyperinflation in the interwar period – or because they are some kind of (prudent) ”Schwäbisch Houswives” -(what ”Merkel” isn’t at all – as she isn’t ”Schwäbisch” at all)

While in reality ”them Germans” right NOW are ”stimulating” and going into debt like NEVER before AND they where the Worlds Champions in ”Non-Austerity Keynes-Stimulus after the Wall came down.
THEN when it became obvious that a lot of ”the Stimulus” -(after the Wall Came down) was outright STUPID – them Germans thought:

We won’t repeat the same mistake in Europe – and from now on – we only will try to stimulate – what makes sense – while don’t our ”Anglo friends” have this… this? – tendency to do economics like the… preverbal… ”drunken sailors”?


UserFriendlyyy 02.19.21 at 4:04 pm

Well, hyperinflation led to Hitler insofar as the response to hyperinflation was 10 years of austerity. If you want it in Hitler’s own words see this:
Hitler very much blames the Young Plan, so as usual everything evil that has ever happened can usually be traced back to something Wall Street did.
Once you get past his (eventually shown to be ) incredibly hypocritical declarations about democracy and free speech it’s quite an interesting read. Also, it looks like the NRA’s complaint: “if you outlaw guns, only criminals will have guns” argument wasn’t very original.


steven t johnson 02.19.21 at 8:47 pm

It is not easy for me to understand the conclusions.

For the first, I do not understand what “excessive private demand” may be? What are the indicators of this? Which economy in Europe in the “armistice” period is an example? Was the rarity of excessive private demand in this period due to the relative failure of the European governments (barring the unacceptable and irrelevant example of the USSR) to accept and act on the first lesson? Or is this anticipation of the need for rationing in war economy?

For the second, as best I can tell, this lesson implicitly contradicts the first. The boundary between necessary extraordinary expenditure and a government foolishly failing to fund its operations resulting in bad things is not clear. Nor is it clear which European economy of this period teaches us this lesson. The US economy? Does this imply the Dawes and Young Plans were ultimately incendiary, burning down European economy by moral hazard of helping a government fail to tax to pay-as-you-go?

The nationalist parties, including the NSDAP, as I remember, all declined after the Ruhr crisis of 1923. They only had their fortunes revived by the depression. The commonplace that inflation leads to fascism strikes me as a commonplace untruth. But then, it seems to me that true hyperinflation is closely, closely associated with defeat in war. Or with economic warfare against a weak state.


Kurt Schuler 02.20.21 at 12:58 am

The problem in Britain and a number of other countries was not austerity, it was overvalued exchange rates. Had the British government continued large monetarily financed deficits after the war, that policy would have failed too in the sense that it would have led to currency devaluation. (That was what happened in Austria, which had a huge postwar inflation and extreme currency depreciation until an economic reform that invovlved, yes, austerity ended it.)

Your notion of austerity here seems crude. Read or reread the book by Alberto Alesina and coauthors, Austerity: When It Works and When It Doesn’t.


KT2 02.20.21 at 1:05 am

JQ -“The most important is the danger of ‘austerity’ policies ”

Cory Doctrow nailing it ” American Lysenkoism kills”!

“How Republicans froze Texas solid 

“The GOP ideology holds that businesses are “efficient” because every penny they squeeze out of their costs is converted to profit. There’s a kernel of truth to this – indeed, the most prominent early theorist of this was Karl Marx!

…” Stalin insisted on applying Lysenkoism to wheat cultivation, to prove that his ideology would work. The result was the famine of 1932-3, which killed tens of millions of people. So many people that there weren’t enough survivors to count the dead.

“The Republican insistence that selfishness is optimal, that companies should only care about maximizing shareholder returns, that deregulation produces efficiencies, that states cannot perform – this is American Lysenkoism.

“American Lysenkoism is why Red States like Texas refused to lock down and have told each county to design its own vaccination and public health program. It’s also why those states refuse climate science.

“American Lysenkoism kills. It’s why the pandemic has killed 500k Americans. It’s why so many Texans are in danger of freezing to death now. It’s also why Republicans – the “party of life” – are performatively refusing to care about these deaths. “…


MisterMr 02.20.21 at 10:31 pm

So, this is becoming a pet peeve of mine, and therefore I’ll make my case here even if it is only tangently related to the OP.

Suppose there is Abe the Representative Agent.
Abe has an income of 1000$ monthly; he own a house priced 100000$, and has a mortgage on that house of 50000$; the price level is 1$=1 muffin.

Situation 1, that is true inflation: Abe’s wage increases to 2000$/month, but the price level also increases to 2$=1 muffin. Abe’s house price also increases to 200000$, and when he has to buy a new house his mortgage also goes up to 100000$.

Situation 2, that I’ll call asset appreciation: Abe’s wage stays still at 1000$, and the price level for consumption goods stays still at 1$=1 muffin. But for some reason, say because the interest rate falls because a lot of people want to save, his house’s price goes up to 200000$, and when he wants to change house his mortgage also goes up to 100000$, although perhaps with lower interests.

Situation 1 is what happened in the 70’s, situation 2 is what happened in recent decades.

Now, both true inflation and asset appreciation are at times explained in terms of an increase in the quantity of money, but the two things are very different and have different effects and problems. A quantity theory of money sucks because it can’t distinguish between the two.
This happens because money is an asset, not a flow, so in order to explain inflation a quantity theory of money has to presuppose a fixed ratio between savings/wealth and nominal income, sometimes referred to as velocity of money, as if money walked by itself on its legs.
But the problem in situation 2, that is our problem, exactly happens because this ratio is not fixed.

But unfortunately, everyone on all sides of the argument about MMT seems to think in terms of quantity of money: MMTers seem to think that inflation arises only when the money supply outpaces maximum productivity, and so it seems to me does the OP; people like Rapier above blame inflation on excess money etc.

I think a better description of the problem IMO is this: keynesian policies of increased demand stimulate capitalists to invest more, which causes employment to go up, which causes the wage share to go up, which causes capitalists to stop investing unless the government continues to stimulate demand that makes it possibile for capitalists to rise prices, thus causing situation 1.

But if the government stimulates the economy by, for example, lowering the tax rate for business, this leads to an increased desired saving level, that lead to situation 2.

Depending on how stimulus policies are calibrated we can get to one or the other situation.

About MMT, the theory itself doesn’t say how the stimulus should be calibrated, all the MMTers I have read are lefties and therefore would balance inflation with taxation on high incomes but unfortunately the most likely effect of it is that governments would like money sovereignity to lower taxes and thus dive even more into 2 (I’m thinking specifically of the italian Lega party but I believe this is common everywhere).

Also if the problem is 2, a correct political response has to lead to a relative deflation in assets, but this is a political no go because it means screwing savers, and one’s own personal savings are sacred in capitalism because they are perceived only way to go up socially and also are perceived as the result of moral probity.


steven t johnson 02.20.21 at 11:18 pm

It should be very strange that Cory Robin can manage to redbait Texas Republican governance, but somehow it seems to be what one should expect. Republican economics are not some sort of outre ideology but widely regarded as orthodox science, taught by most academics and endorsed by most business leaders, most politicians, most clergymen, most lawyers. Economic orthodoxy about the superiority of markets is a staple of elementary school education. This is a tribute, as its proponents see it, to the discovery of the eternal truths about human nature.

Lysenkoism was an ideology that denied the orthodox view of nature (as in genetics.) It was the modern equivalent of firing evolutionary psychologists. Lysenkoism in the US would the equivalent of firing all the evolutionary psychologists. And in the field of economics the equivalent of Lysenkoism would be firing all the economists who weren’t MMTers and shutting down the Wall Street Journal and abolishing the teaching of “law and economics” and so on and so forth.

The causes of the famine are not usually attributed to Lysenkoism. Tens of millions and no survivors to count the dead? Redbaiting the Republicans is odd enough but this verges on hysterics worthy of, well, the list is too long…


Rapier 02.21.21 at 6:22 pm

My bad on the money thing. Never talk about the money with an Economist.


reason 02.21.21 at 9:10 pm

Kurt – the problem for whom exactly? No economic policy hurts everyone. But are seriously suggesting that for countries with their own currencies the exchange rate is independent of economic policy? Austerity generally tends to me low government spending, i.e. fiscal constraint but an overvalued currency suggests a combination of loose fiscal policy (perhaps reflecting excessively low taxes) and tight monetary policy. If this was the case, it definitely wasn’t the intention, which was was surely the opposite.


EWI 02.21.21 at 9:46 pm

Churchill’s policies were disastrous, but the damage was mostly limited to Britain.

And the Irish Free State, whose conservative Cumann na nGaedheal government (main predecessor of today’s Fine Gael) adopted a disastrous economic programme which included pegging the Irish pound to the English one.


nastywoman 02.22.21 at 4:27 am

so –
in other (Wikipedia) words:
”French speakers refer to the period as the “Années folles” (“Crazy Years”),[2] emphasizing the era’s social, artistic, and cultural dynamism.

The economic prosperity experienced by many countries during the 1920s (especially the United States) was similar in nature to that experienced in the 1950s and 1990s. Each period of prosperity was the result of a paradigm shift in global affairs. These shifts in the 1920s, 1950s, and 1990s, occurred in part as the result of the conclusion of World War I and Spanish flu, World War II, and the Cold War, respectively.
The 1920s saw foreign oil companies begin operations throughout South America. Venezuela became the world’s second largest oil producing nation.[3]

In some countries the 1920s saw the rise of radical political movements, especially in regions that were once part of empires. Communism spread as a consequence of the October Revolution and the Bolsheviks’ victory in the Russian Civil War. Fear of the spread of Communism led to the emergence of far right political movements and fascism in Europe. Economic problems contributed to the emergence of dictators in Eastern Europe and the Balkans, to include Józef PiÅ‚sudski in the Second Polish Republic, and Peter and Alexander KaraÄ‘orÄ‘ević in the Kingdom of Yugoslavia.
The devastating Wall Street Crash in October 1929 is generally viewed as a harbinger of the end of 1920s prosperity in North America and Europe”.

and what a disappointing Wikipedia explanation?
Could… somebody please change it?


reason 02.22.21 at 8:49 am

Kurt Schuler
Having looked again at what you wrote – I have now no idea what you are saying. These two sentences seem to directly contradict one another:
“The problem in Britain and a number of other countries was not austerity, it was overvalued exchange rates. Had the British government continued large monetarily financed deficits after the war, that policy would have failed too in the sense that it would have led to currency devaluation.”

How is a currency devaluation not a solution to an overvalued currency?


MisterMr 02.22.21 at 11:46 pm

@Rapier at 13

If you are referring to me, I do not have a degree in economics.


J-D 02.23.21 at 10:55 am

@Rapier at 13

If you are referring to me, I do not have a degree in economics.

Or, if you are referring to me, I also do not have a degree in economics.


Tm 02.23.21 at 10:56 am

“It should be very strange that Cory Robin can manage to redbait Texas Republican governance”

Finally figured out the confusion: You are referring to Cory Doctorow, referenced at 10 by KT2.

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