Fiscal policy under constraints : fiscal capacity and the (in-)stability of government financing during the Great Depression

Abstract

The Great Depression, and the interwar period more generally, were characterized by macroeconomic mismanagement. Fiscal policy, in particular, was essentially not used to fight the slump. Despite this, I find that a higher degree of fiscal capacity helped countries reduce the cyclical volatility of their governments' financing and, thus, to run stabilizing - or, at least, less destabilizing - fiscal policies. This smoothing effect worked principally by facilitating countries' access to borrowing. Thus, interwar governments were constrained in their policy choices by past investments in their fiscal systems, and not just Gold Standard membership and ideology, as commonly held in the literature.