Internal Devaluation and the Road to Wigan Pier, by Paul Krugman, in NY Times: Greg Ip, in correspondence, directs me to Chapter 3 of the latest IMF World Economic Outlook, which among other things contains an analysis of a case that bears directly on the attempts of euro area countries to restore economic health through fiscal austerity and internal devaluation: Britain’s return to the gold standard after World War I.
As the report says, Britain demonstrated a fairly awesome commitment to austerity:
To achieve its objectives the U.K. government implemented a policy mix of severe fiscal austerity and tight monetary policy. The primary surplus was kept near 7 percent of GDP throughout the 1920s.This was accomplished through large expenditure decreases, courtesy of the “Geddes axe,” and a continuation of the higher tax levels introduced during the war. On the monetary front, the Bank of England raised interest rates to 7 percent in 1920 to support the return to the prewar parity, which—coupled with the ensuing deflation—delivered extraordinarily high real rates.
Sad to say, however, the confidence fairy never arrived. Britain suffered prolonged economic stagnation even before the onset of the Great Depression:
And it didn’t even succeed in reducing the debt/GDP ratio, because deflation and slow growth outweighed the effects of austerity.
Not a good omen for Europe.