The Wall Street Journal has a new editorial discussing the need for monetary reform. There is much in the article that I agree with, including the claim that President Trump’s call for lower rates might backfire by making the Fed want to look more independent, and that there is no obvious current need for monetary stimulus.
The problem occurs when the Journal gets around to discussing monetary policy options:
“Mr. Trump could ask his Treasury to lead the developed world’s finance ministers and central bankers toward a more stable system. . . .”
“They could put together a task force of American and foreign experts to debate and recommend how to navigate the transition from post crisis policy and promote more currency stability. Experts who have written for us over the years include Messrs. Warsh and Taylor, economists Steve Hanke, Glenn Hubbard and Judy Shelton, former Fed Chair Paul Volcker, investor and philanthropist Sean Fieler and historian and investor Lewis Lehrman, among others.”
This list of possible reformers mixes together economists who have argued for a gold standard, a fixed exchange rate regime, and floating exchange rate regimes, with and without explicit rules for setting the interest rate target. I do believe that some sort of rules based approach is desirable, but much of the editorial’s discussion focuses on the alleged problem of foreign exchange rate instability, which is actually a feature, not a bug, of sound monetary policy.
History is littered with examples where rigid exchange rates contributed to economic slumps, including much of the world in the early 1930s, Argentina from 1998 to 2001, and southern Europe after 2008. In the first two cases, depressions were wrongly attributed to laissez-faire capitalism, which led to the adoption of exactly the sort of interventionist policies that the Journal rightly opposes.
Monetary stability, however, is a seductive concept that can be defined in a wide variety of ways, some of which are consistent with broader economic stability and some of which are not. Ninety years ago, monetary stability meant a stable price of gold. During the Bretton Woods era (after WWII), many thought of monetary stability in terms of a fixed exchange rate against the US dollar. More recently, a stable inflation rate of roughly two percent has become widely used as a metric of stability, although there is increasing interest in stabilizing the growth rate of nominal GDP (NGDP) at roughly four percent per year.
Consider the Swiss franc, which has recently been pretty stable in terms of purchasing power (near zero inflation) and NGDP growth, but somewhat unstable in terms of exchange rates and wildly unstable in terms of gold prices. Which stability should count? I would argue for the most useful measure of monetary stability, which might be stabilizing growth in the product of the money supply (the total amount of money currently in circulation) and velocity (the rate at which money moves through the economy).
A steady growth rate of four percent in NGDP will lead to more stable labor markets (low unemployment) and more stable financial markets (fewer financial crises). In this system, the central bank adjusts the money supply to offset movements in the velocity of circulation. In contrast, Argentina suffered a depression and financial crisis at the turn of the millennium, despite stabilizing their currency against the dollar. The US experienced depression and financial crisis in 1930-32, despite the dollar having a stable value against gold. Greece’s recent problems were almost inevitable given their reckless spending, but the resulting unemployment and depression was far worse than necessary, as they no longer had a drachma to devalue once they had adopted the Euro.
These previous economic crises were not solely due to fixed exchange rate regimes, but there is evidence that the lack of exchange rate flexibility made it more difficult to stabilize the economies that did get into trouble, and this led to other counterproductive interventions in the economy.
By all means, let’s have stable money, but let’s also be careful to define monetary stability in a way that is most likely to allow the free market system to be effective---and that means stable growth nominal GDP. This sort of regime is also more politically feasible, as it has support among both liberal and conservative economists. The Journal’s proposed approach is likely to only draw support from more conservative economists, and thus be very difficult to implement.
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