Working Paper: CEPR ID: DP10761
Authors: Stefan Gerlach; Peter Kugler
Abstract: Expectations of Sterling returning to Gold have been disregarded in empirical work on the US dollar ? Sterling exchange rate in the early 1920s. We incorporate such considerations in a PPP model of the exchange rate, letting the probability of a return to gold follow a logistic function. We draw several conclusions: (i) the PPP model works well from spring 1919 to spring 1925; (ii) wholesale prices outperform consumer prices; (iii) allowing for a return to gold leads to a higher speed of adjustment of the exchange rate to PPP; (iv) interest rate differentials and the relative monetary base are crucial determinants of the expected return to gold; (v) the probability of a return to Gold peaked at about 72% in late 1924 and but fell to about 60% in early 1925; and (vi) our preferred model does not support the Keynes? view that Sterling was overvalued after the return to gold.
Keywords: Back to Gold; Sterling; Exchange Rate; PPP Model
JEL Codes: E5; F31; N1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| PPP model (H44) | exchange rate behavior (F31) |
| Keynes' assertion of overvaluation (D46) | exchange rate behavior (F31) |
| interest rate differentials (E43) | expected return to gold (G17) |
| relative monetary base (E50) | expected return to gold (G17) |
| expected return to gold (G17) | exchange rate adjustments (F31) |
| expected return to gold (G17) | speed of adjustment of the exchange rate to PPP (F31) |
| return to gold (L72) | exchange rate adjustment speed (F31) |