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Handbook of Exchange Rates by Lucio Sarno, Ian Marsh, Jessica James

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6.8 Establishment and Assessment of a Fixed Exchange Rate in Interwar Period

This section discusses the use of PPP by government in connection with the setting of a new exchange rate. In the interwar period, there were two interesting cases of PPP computations by the government in order to establish a new, or return to a former, exchange rate: the United Kingdom (1925) and France (1926).

6.8.1 United Kingdom

The U.K. return to gold on April 28, 1925 was the (sole) case of a government predetermining the exchange rate—in this case the prewar gold parity—and using PPP to measure the amount of price-level adjustment at home or abroad required to maintain the rate. France, Czechoslovakia, and Belgium applied PPP to compute the new exchange rate, although less so in France than in the other two countries.

No doubt the U.K. experience is the most famous of all governmental applications of PPP. The floating pound had appreciated from 10% to less than 2% below parity—caused by anticipation of a return to parity, whereupon the prewar exchange value of the pound ($4.86656 per pound) was restored. There was never a question that return to the gold standard would take place, and at the prewar rate. As Sayers (1936, p. 314) commented: “The restoration of the gold standard, at a tacitly assumed rate of 4.86, was government policy throughout …”. Moggridge (1922, p. 14) agreed: “The Authorities had as their primary aim a return to gold … a return to the pre-war parity.” There was never any choice ...

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