Working Paper Series no. 50: Threat of a Capital Levy, Expected Devaluation and Interest Rates in France during the Interwar Period

Abstract

This paper tries to improve the understanding of the French interwar monetary situation by using thoroughly one indicator: long-term interest rates. As such, it could be attacked from a methodological point of view as relying excessively on that indicator and on a small number of hypothesis (although we have empirical arguments for each of these). We do consider that if each one of our hypothesis (and then our measures) may be discussed, the global picture we draw is the only one which puts all the available data in a consistent order. This picture is different from the prevailing one in some aspects concerning the Poincaré stabilization, and reinforces one of the interpretations of the 1930s.
First, the interest rates during the Cartel period were quite high (about 16%), but very far from what one would believe while on the edge of hyperinflation. Moreover, the increase in the rate after 1924 (when the market implied rate was 13%) could be explained by the threat of a capital levy. The apex of the exchange rate crisis from May to July 1926 (the rate going from 140 to 200 francs per pound) appears as a speculative bubble, since exchange rate expectations (as deducted from the interest rate differential between interest-rate-guaranteed and usual government bonds) were already declining and were quite below the actual rate. Second, the low interest rates in France during the 1928-1931 period reflected expectations of appreciation of the franc vis-à-vis the pound. Symmetrically, after 1931, expectations of depreciation of the franc account for the high level of interest rates in France.
The interpretation that results from these findings is the following: the politically motivated struggle about the capital levy increased the interest rates in 1925 but were not as such important enough to forbid a stabilization which was still possible and expected even before Poincaré took over. His supposed victory on inflation was then more luck than virtue since no hyperinflation had been beginning and the return to stability (although at a somewhat lower exchange rate) was likely. This episode had two important consequences: first it contributed to an excessively low stabilization level for the franc, which was reflected in expectations of reevaluation lasting up to the devaluation of the pound. Second, the myth of the franc Poincaré saving France from a sharp political struggle and from the pain of inflation explains partly the reluctance of all political parties relatively to any devaluation in the 1930s. Given the strong opposition to capital flow restrictions and the contradiction between a monetary financing of the budget deficit and explicit deflationary measures, expectations of a devaluation rapidly appeared. They explain the rise of interest rates in France during the depression.

Pierre-Cyrille Hautcoeur and Pierre Sicsic
January 1998

Classification JEL : E43, N14, N24