Shooting on a moving target: explaining European bank rates during the interwar period

This paper describes how countries adjusted their monetary policy in response to the Great Depression. We estimate central bank rate reaction functions for a panel of 22 countries during the years 1925-1936. We find that countries moved away from convertibility towards a more 'modern' monetary policy based on exchange rate stabilisation, but not yet output stabilisation or even modern price level targeting. This move to exchange rate stabilisation was accompanied by the formation of monetary policy blocs around pre-existing economic relations. Countries' interwar policy choices offer lessons for countries remaining in or choosing to join the European Monetary Union today.