Mussolini’s great monetary policy failure

Benito Mussolini is known for having been a horrible warmongering fascist dictator. However, he was also responsible for a major failed monetary experiment – the so-called Battle of the Lira.

Hence, in 1926 Mussolini announced a major revaluation of the Italian Lira as part of his general plan to revive the greatness of Italy.

This is how the Battle of the Lira was described in the New York Times in August 1927:

“It is just one year since Premier Mussolini, speaking at Pesaro, delivered that oration, destined to remain famous in the annals of modern Italian history, in which he announced his intention to revalue the lira.

‘We shall never inflict upon our wonderful Italian people, which for four years has been working with ascetic discipline and is ready for even greater sacrifieces, the moral shame and economic catastrophe of failure of the lira,’ he declared.

Looking back upon the last year, one must admit that Primier Mussolini has more than kept his word. In August 1926, the average exchange rate was 30 1/2 lira to the dollar. By October it had already dropped to 27 …the lira steadily continued its descent till in May (1927) it reached 18 to the the dollar, where it has remained ever since”

Hence, Mussolini engineered a nearly 70% revaluation of the lira in less than one year. Not surprisingly the economic impact was not positive. This how that is described in the same New York Times article:

“But the result has not been obtained without servere…jolts affecting all classes of citizens.

…Revaluation has led to a period of general stagnation and lack of enterprise in industry, for the gold value of money has increased automatically while the revaluation process was in progress and people preferred to leave their money in banks to rising it in ventures of any kind.

Unemployment is twice as high as it was in this month last year and greater than it has been at any time since 1924. Average quotations on stock exchanges have fallen 40 per cent. Wholesale prices have fallen about 30 per cent, but retail prices lag far behind and show a decrease of less than 15 per cent…

…Despite these somewhat depressing indications, the Government is convinced that the benefits of revaluation will ultimately far outweigh the drawbacks. The official opinion, indeed, is that now that the whole country has become adjusted to the new value of the lira, a rapid improvement will be expirienced.”

That of course never happened. Instead the Italian economy was hit by yet another shock in 1929 when the global crisis hit.

Finally in 1934 Mussolini decided to give up the gold standard and in October 1936 the lira was devalued by 41%.

What role Mussolini’s failed monetary policy played in his domestic policies and particularly in the foreign policy “adventures” – his war against Abyssinia in 1935-36 and his decision to ally himself with Hitler and Nazi-Germany in WWII – I don’t know, but there is nothing like war to take away the attention from failed economic policies.

Or as it was expressed in an article in New York Times in April 1935 at the start on Mussolini war against Abyssinia (but before the 1936 devaluation):

Behind each new political move in Europe, which expresses itself in the mobilization of larger armies, may generally be found an economic cause.

The article also touches on another key issue – the fact that (über) tight monetary policy historically has led to protectionist measures and that the logical consequence of such protectionist measures often is war:

The foreign trade of Italy is, figuratively, “shot to pieces.” The decrees against imports , the unwillingness to do business except where equal valued are exchanged by a foreign nation and the high rate of the lira have produced an alarming situation for a country that today under unobstructed movements of goods, would have an unfavorable trade balance.

One of the major efforts of Mussolini has been to place Italy on a self-supporting basis. Much has been done in this direction. As Italy is poor in natural resources that enter into processes of manufacture, the handicaps to attaining self-sufficiency are not easy to surmount.”

It is too bad today’s European policy makers didn’t study any economic history.

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Related blog posts:

“If goods don’t cross borders, armies will” – the case of Russia
Denmark and Norway were the PIIGS of the Scandinavian Currency Union

And posts on the early 1930s:

1931:
The Tragic year: 1931
Germany 1931, Argentina 2001 – Greece 2011?
Brüning (1931) and Papandreou (2011)
Lorenzo on Tooze – and a bit on 1931
“Meantime people wrangle about fiscal remedies”
“Incredible Europeans” have learned nothing from history
The Hoover (Merkel/Sarkozy) Moratorium
80 years on – here we go again…
“Our Monetary ills Laid to Puritanism”
Monetary policy and banking crisis – lessons from the Great Depression

1932:
“The gold standard remains the best available monetary mechanism”
Hjalmar Schacht’s echo – it all feels a lot more like 1932 than 1923
Greek and French political news slipped into the financial section
Political news kept slipping into the financial section – European style
November 1932: Hitler, FDR and European central bankers
Please listen to Nicholas Craft!
Needed: Rooseveltian Resolve
Gold, France and book recommendations
“…political news kept slipping into the financial section”
Gideon Gono, a time machine and the liquidity trap
France caused the Great Depression – who caused the Great Recession?

1933:
Who did most for the US stock market? FDR or Bernanke?
“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression
Remember the mistakes of 1937? A lesson for today’s policy makers
I am blaming Murray Rothbard for my writer’s block
Irving Fisher and the New Normal

 

Putin’s hopes for monetary miracles

There is a lot of focus on what Russian President Vladimir Putin is saying these days. However, it is mostly about geopolitics and much less about his views on economics and particularly on central banking. However, I came across some interesting comments from Putin on monetary policy, which quite well illustrates some of the problems with his – or rather his lack of – economic thinking.

This is from a recent article from Reuters:

Russian President Vladimir Putin told the country’s top finance and economy officials on Wednesday that the current forecast for gross domestic product this year was unacceptable.

“I will again stress that the existing growth rates and those forecast by the government cannot satisfy us,” Putin told Central Bank Governor Elvira Nabiullina, Finance Minister Anton Siluanov, Kremlin economic adviser Andrei Belousov and others.

…The weakening rouble, which has lost more than 10 percent against the dollar so far this year to trade at all-time lows , is also putting the central bank’s goal of 5 percent inflation this year in jeopardy.

“(We need to) … keep inflation at an acceptable, low level,” Putin said. He did not give details.

So Putin wants higher growth and lower inflation. Well, that is just great. Lower inflation and higher growth would certainly be great for Russia. The problem of course is whether the Russian central bank can deliver this?

Anybody who studied the AS/AD framework knows that monetary policy cannot deliver what Putin wants.

The only way to get lower inflation and higher real GDP growth is through a positive supply shock and we all know that the central bank – either the Russian or any other any other central bank in the world – cannot control what happens to the supply side of the economy.

CBR governor Nabiullina can fully control nominal spending (aggregate demand) in the Russian economy, but she has no powers to control aggregate supply. Unfortunately for her the Russian economy is presently experiencing a very significant negative aggregate supply shock – mostly due to capital outflow related to Putin’s de facto annexation of Crimea.

We can understand this negative supply shock by focusing on a number of different – but related – factors, which should be seen as part of the aggregated supply shock feeding through the Russian economy at the moment.

First of all the we are presently seeing massive capital outflows out of Russia as foreign investors are reducing exposure to the Russian economy and Foreign Direct Investments into Russian has probably come to a “sudden stop”. Lower investments obviously mean less capital accumulation and hence lower productivity growth. This of course is a negative supply shock.

Second, as a consequence of the geopolitical developments investors are undoubtedly seeing more of what Robert Higgs have called “regime uncertainty”. Will Russia become a more closed economy in the future? Will government come to play even bigger role in the economy and will we see even more regulation and corruption? All these factors are impacting investments – both foreign and domestic – negatively.

Third, the massive capital outflows have pushed the Russian rouble weaker. As a result import prices are rising significantly. That is increasing input costs in Russian industry and is hence also a negative supply shock.

Not only are these factors likely to be very negative, but they are likely also fairly permanent in nature and more importantly the Russian central bank can do very little about it.

The negative supply shock is illustrated in the graph below. The three factors described above are all adding up to pushing the Russian Aggregate Supply (AS) curve to the left. The result is of course that real GDP growth drops from y to y’ and that inflation increases from p to p’. This is not exactly what the doctor – or rather president Putin – ordered.

Negative supply shock demand shock Russia

So now governor Nabiullina can chose to ignore one of two demands from Putin. Either she tries to lower inflation or she tries to spur real GDP growth. However, if the shock to aggregate supply is permanent then she will not even be able to push up real GDP growth – at least not for long as inflation expectations are likely to “catch up” with any monetary easing fast.

She can, however, deliver lower inflation by tightening monetary conditions and this is of course exactly what she has done. The problem is of course that that comes at a cost – likely a large cost – of killing growth.

This is also illustrated in the graph above. When monetary conditions are tightened significantly (CBR as likely intervened for as much as USD 20bn in the currency markets over the past month and increased it key policy rate by 150bp) then the aggregate demand (AD) curve shifts to the left – pushing inflation down to p’’, but also further reducing real GDP growth to y’’ from y’.

In fact most economists who are covering the Russian economy have recently been revising down their growth forecasts for the Russian economy in 2014. And goes for myself as well and I am quite convinced that the Russian economy will go into recession and experience negative quarter-to-quarter GDP growth in at least the next couple of quarters.

Former Russian Finance Minister Alexei Kudrin agrees. Mr. Kudrin a couple of days ago said that he now expect a Russian recession in 2014 (See here).

So why is the CBR tightening monetary policy when it so obviously is likely to lead to a sharp slowdown in Russian growth? I most say I continue to be puzzled by Emerging Markets central banks around world, which over the past year have moved to sharply tightening monetary conditions to curb exchange rate depreciation despite these central banks officially operate floating exchange rate regimes.

The most likely explanation in my view is that policy makers – on strong pressures from governments – are politically motivated by the fact that currency weakness is see as being politically embarrassing for local rulers such as Russia’s President Putin or Turkey’s Prime Minister Erdogan.

The paradox here is that this fear-of-floating likely is doing a lot more damage to the Russian economy at the moment than any of the sanctions, which this week have been introduced by the EU and the US.

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