THE POSTWAR INTERNATIONAL FINANCIAL ORDER, 1918 - 1932 (MONETARY THEORY, POLICY, HISTORY)

This dissertation consists of a model of the monetary policy process, and an application of the model to the post-World War I financial and macroeconomic policy system. Orthodox money multiplier models mis-specify the transmission mechanism of the monetary policy. An alternative model is constructed from the micro-foundations of the credit supply process. The model locates the transmission channel of monetary policy in the impact of policy initiatives on the expectations of portfolio holders in the financial markets. If monetary policy initiatives have a negligible impact on expectations, they will not have a significant impact on the course of real economic activity in a capitalist economy with sophisticated financial markets and more than nominal business cycles. The expectations formation process is analyzed to derive the institutional configuration and policy stance that contribute to a tight connection between monetary policy initiatives and the expected profitability of credit creation. The analysis concludes that monetary policy, while potentially powerful, is an inherently unstable platform for macroeconomic control. The monetary authority\u27s control of expectations can fluctuate dramatically in a short space of time. If the monetary authority is viewed as technically weak vis a vis market forces or politically vulnerable to competing macroeconomic policy centers, it will face rapid and severe declines in monetary policy effectiveness. The motivation for the construction of the postwar financial order was a great fear by the elites of the social and political consequences of modest amounts of inflation. The central bank was elevated to the status of a macroecomonic planner, and given the task of keeping the economy inflation free, and provided with a monopoly on macroeconomic policy. An asymmetrical, pro-cyclical policy stance promised to cap booms and promote liquidations, that is, to enforce a severe recession following an expansion. Robust central bank independence protected unpopular policies. The system was effective, but chronically inflexible, being deliberately designed to be inhospitable to expansionary policy, and incapable of conforming to policy pressures from the electorate. During 1929 - 1933 the system worked as design, and paralyzed expansionary macroeconomic policy initiatives. The disastrous results discredited the system and its supporters