2017-06-19 18:10:21 UTC
by Tim Worstall, June 19, 2017, fee.org
Many mainstream economists, perhaps a majority of those who have an
opinion, are opposed to tying a central banks hands with any explicit
monetary rule. A clear majority oppose the gold standard, at least
according to an often-cited survey. Why is that?
First some preliminaries. By a gold standard I mean a monetary
system in which gold is the basic money. So many grains of gold define
the unit of account (e.g. the dollar) and gold coins or bullion serve
as the medium of redemption for paper currency and deposits.
By an automatic or classical gold standard I mean one in which
there is no significant central-bank interference with the functioning
of the market production and arbitrage mechanisms that equilibrate the
stock of monetary gold with the demand to hold monetary gold.
The United States was part of an international classical gold standard
between 1879 (the year that the dollars redeemability in gold finally
resumed following its suspension during the Civil War) and 1914 (the
First World War).
Serving the Status-Quo
Why isnt the gold standard more popular with current-day economists?
Milton Friedman once hypothesized that monetary economists are loath
to criticize central banks because central banks are by far their
largest employer. Providing some evidence for the hypothesis, I have
elsewhere suggested that career incentives give monetary economists a
status-quo bias. Most understandably focus their expertise on serving
the current regime and disregard alternative regimes that would
dispense with their services. They face negative payoffs to
considering whether the current regime is the best monetary regime.
Here I want to propose an alternative hypothesis, which complements
rather than replaces the employment-incentive hypothesis. I propose
that many mainstream economists today instinctively oppose the idea of
the self-regulating gold standard because they have been trained as
social engineers. They consider the aim of scientific economics, as of
engineering, to be prediction and control of phenomena (not just
They are experts, and an automatically self-governing gold standard
does not make use of their expertise. They prefer a regime that values
them. They avert their eyes from the possibility that they are trying
to optimize a Ptolemaic system, and so prefer not to study its
The actual track record of the classical gold standard is superior in
major respects to that of the modern fiat-money alternative. Compared
to fiat standards, classical gold standards kept inflation lower
(indeed near zero), made the price level more predictable (deepening
financial markets), involved lower gold-extraction costs (when we
count the gold extracted to provide coins and bullion to private
hedgers under fiat standards), and provided stronger fiscal
The classical gold standard regime in the US (1879-1914), despite a
weak banking system, did no worse on cyclical stability, unemployment,
or real growth.
Unnecessary Monetary Policy Tightening
The classical gold standards near-zero secular inflation rate was not
an accident. It was the systemic result of the slow growth of the
monetary gold stock. Hugh Rockoff (1984, p. 621) found that between
1839 and 1929 the annual gold mining output (averaged by decade) ran
between 1.07 and 3.79 percent of the existing stock, with the one
exception of the 1849-59 decade (6.39 percent growth under the impact
of Californian and Australian discoveries).
Furthermore, an occasion of high demand for gold (for example a large
country joining the international gold standard), by raising the
purchasing power of gold, would stimulate gold production and thereby
bring the purchasing power back to its flat trend over the longer
A recent example of a poorly grounded historical critique is provided
by textbook authors Stephen Cecchetti and Kermit Schoenholtz. They
imagine that the gold standard determined money growth and inflation
in the US until 1933, and so they count against the gold standard the
US inflation rate in excess of 20% during the First World War
(specifically 1917), followed by deflation in excess of 10% a few
years later (1921).
These rates were actually produced by the policies of the Federal
Reserve System, which began operations in 1914. The classical gold
standard had ended during the Great War, abandoned by all the European
combatants, and did not constrain the Fed in these years.
Cecchetti and Schoenholtz are thus mistaken in condemning the gold
standard for producing a highly volatile inflation rate. (They do
find, but do not emphasize, that average inflation was much lower and
real growth slightly higher under gold.) They also mistakenly blame
the gold standard not the Federal Reserve policies that prevailed,
nor the regulatory restrictions responsible for the weak state of the
US banking system for the US banking panics of 1930, 1931, and 1933.
Studies of the Feds balance sheet and activities during the 1930s
have found that it had plenty of gold (Bordo, Choudhri and Schwartz,
1999; Hsieh and Romer, 2006, Timberlake 2008). The tight monetary
policies it pursued were not forced on it by lack of more abundant
There are of course serious economic historians who have done valuable
research on the performance of the classical gold standard and yet
remain critics. Their main lines of criticism are two. First, they too
lump the classical gold standard together with the very different
interwar period and mistakenly attribute the chaos of the interwar
period to the gold standard mechanisms that remained, rather than to
central bank interference with those mechanisms.
In rebuttal Richard Timberlake has pertinently asked how, if it was
the mechanisms of the gold standard (and not central banks attempts
to manage them) that destabilized the world economy during the
interwar period, those same mechanisms managed to maintain stability
before the First World War (when central banks intervened less or, as
in the United States, did not exist)?
Here, I suggest, a strong pre-commitment to expert guidance acts like
a pair of blinders. Wearing those blinders, even if it is seen that
the prewar system differed from and outperformed the interwar system,
it cannot be seen that this was because the former was comparatively
self-regulating and the latter was comparatively expert-guided.
Second, it is always possible to argue in defense of expert guidance
that even the classical gold standard was second-best to an ideally
managed fiat money where experts call the shots. Even if central
bankers operated on the wrong theory during the 1920s, during the
Great Depression, and under Bretton Woods, not to mention during the
Great Inflation and the Great Recession, today they operate (or can be
gotten to operate) on the right theory.
In the worldview of economics as social engineering, monetary
policy-making by experts must almost by definition be better than a
naturally evolved or self-regulating monetary system without top-down
guidance. After all, the experts could always choose to mimic the
self-regulating system in the unlikely event that it were the best of
all options. (In the most recent issue of Gold Investor, Alan
Greenspan claims that mimicking the gold standard actually was his
policy as Fed chairman.) As experts they sincerely believe that we
can do better by taking advantage of expert guidance. How can expert
guidance do anything but help?
3 Ways to Fail
Expert-guided monetary policy can fail in at least three well-known
ways to improve on a market-guided monetary system.
First, experts can persist in using erroneous models (consider the
decades in which the Phillips Curve reigned) or lack the timely
information they would need to improve outcomes. These were the
reasons Milton Friedman cited to explain why the Feds use of
discretion has amplified rather than dampened business cycles in
Second, policy-makers can set experts to devising policies to meet
goals that are not the publics goals. This is James Buchanans case
for placing constraints on monetary policy at the constitutional
Third, where the public understands that the central bank has no
pre-commitments, chronically suboptimal outcomes can result even when
the central bank has full information and the most benign intentions.
This problem was famously emphasized by Finn E. Kydland and Edward C.
These lessons have not been fully absorbed. A central bank that
announces its own inflation target (as the Fed has), and especially
one that retains a dual mandate to respond to real variables like
the unemployment rate or the estimated output gap, retains discretion.
It is free to change or abandon its inflation-rate target, with or
without a new announcement. Retaining discretion the option to
change policy in this way carries a cost.
The money-using public, uncertain about what the central bank experts
will decide to do, will hedge more and invest less in capital
formation than they would with a credibly committed regime. A
commodity standard especially without a central bank to undermine
the redemption commitments of currency and deposit issuers more
completely removes policy uncertainty and with it overall uncertainty.
Blaming Gold for Failed Policy
Speculation about the pre-analytic outlook of monetary policy experts
could be dismissed as mere armchair psychology if we had no textual
evidence about their outlook. Consider then, a recent speech by
Federal Reserve Vice Chairman Stanley Fischer.
At a May 5, 2017 conference at the Hoover Institution, Fischer
addressed the contrast between Committee Decisions and Monetary
Policy Rules. Fischer posed the question: Why should we have
monetary policy decisions made by a committee rather than by a
rule? His reply: The answer is that opinions even on monetary
policy differ among experts.
Consequently we prefer committees in which decisions are made by
discussion among the experts who try to persuade one another. It is
taken for granted that a consensus among experts is the best guide to
monetary policy-making we can have.
Emphasis on a single rule as the basis for monetary policy implies
that the truth has been found, despite the record over time of major
shifts in monetary policy from the gold standard, to the Bretton
Woods fixed but changeable exchange rate rule, to Keynesian
approaches, to monetary targeting, to the modern frameworks of
inflation targeting and the dual mandate of the Fed, and more. We
should not make our monetary policy decisions based on that
assumption. Rather, we need our policymakers to be continually on the
lookout for structural changes in the economy and for disturbances to
the economy that come from hitherto unexpected sources.
In this passage Fischer suggested that historical shifts in monetary
policy fashion warn us against adopting a non-discretionary regime
because they indicate that no true regime has been found. But how
That governments during the First World War chose to abandon the gold
standard (in order to print money to finance their war efforts), and
that they subsequently failed to do what was necessary to return to a
sustainable gold parity (devalue or deflate), does not imply that the
mechanisms of the gold standard rather than government policies that
overrode them must have failed.
Observed changes in regimes and policies do not imply that each new
policy was an improvement over its predecessor unless we take it for
granted that all changes were all wise adaptations to exogenously
changing circumstances. Unless, that is, we assume that the experts
guiding monetary policies have never yet failed us.
Better, Because Science
Fischer further suggested that a monetary regime is not to be
evaluated just by the economys performance, but by how policy is
made: a regime is per se better the more it incorporates the latest
scientific findings of experts about the current structure of the
economy and the latest models of how policy can best respond to
If we accept this as true, then we need not pay much if any attention
to the gold standards actual performance record. But if instead we
are going to judge regimes largely by their performance, then
replacing the automatic gold standard by the Federal Reserves
ever-increasing discretion cannot simply be presumed a good thing. We
need to consult the evidence. And the evidence since 1914 suggests
Contrary to Fischer, there is no good reason to presume that
expert-guided monetary regimes get progressively better over time,
because there is no filter for replacing mistaken experts with better
experts. We have no test of the successful exercise of expertise in
monetary policy (meaning, superiority at correctly diagnosing and
treating exogenous monetary disturbances, while avoiding the
introduction of money-supply disturbances) apart from ex post
evaluation of performance.
The Feds performance does not show continuous improvement. As
previously noted, it doesnt even show improvement over the pre-Fed
regime in the US.
A fair explanation for the Feds poor track record is Milton
Friedmans: the information necessary for successful expert guidance
of monetary policy is simply not available in a timely fashion.
Those who recognize this point will be open to considering the merits
of moving, to quote the title a highly pertinent article by Leland B.
Yeager, toward forecast-free monetary institutions. Experts who
firmly believe in expert guidance of monetary policy, of course, will
not recognize the point. They will accordingly overlook the successful
track record of the automatic gold standard (without central bank
management) as a forecast-free monetary institution.
Reprinted from Alt-M.
Tim Worstall is a Fellow at the Adam Smith Institute in London