Trade, Exchange Rate Regimes and Output Co-Movement: Evidence from the Great Depression

A large body of cross-country empirical evidence identifies monetary policy and trade integration as key determinants of business cycle co-movement. Partially consistent with this, many argue that the re-emergence of the gold standard allowed for the global transmission of a deflationary shock in 1929 that culminated in the Great Depression. It is puzzling then to see decreased co-movement between 1920 and 1927 when international integration increased and nations returned to the gold standard. Fixed exchange rates and global trade were also on the rise after 1932, but co-movement declined again. Our empirical results shows that exchange rate regimes and trade were associated with higher co-movement at the bilateral level while common shocks and exchange control policies also mattered. Much of the fall after 1932 was driven by the rise of smaller blocs of monetary and trade cooperation and an inter-bloc fall in co-movement.