Saturday, October 4, 2014

Brief Thoughts on the Gold Standard as a Rule-Based Regime

I'm making what I hope are some final changes to "Wither Gold", a paper where I integrate gold flows and monetary policy decision rules into Austrian analysis. It has struck me that the gold standard is actually just a complex rule-based regime. These rules were not altogether unambiguous.
Identifying Federal Reserve policy as a violation of the “rules of the game” reveals a weakness of the gold standard. Not only was there no mechanism of enforcement for these “rules”. The “rules of the game” were an implicit agreement between authorities of different national central banks. The precise rules governing central bank management of the gold standard were not always clear. When the Federal Reserve System contracted the monetary base under the leadership of New York Federal Reserve governor Benjamin Strong in 1920, domestic prudence demanded that the Federal Reserve raise interest rates and reserve levels. At one point, Strong defended the systems role in maintaining stability.[1] Strong may have felt justified by the ends of this policy, but the means was dangerous. 
The Federal Reserve tended to follow the “Real Bills Doctrine” at the time, but its implementation was imperfect (Timberlake 2007). Again in 1927, a political battle between Strong and Miller as Strong wanted to help stabilize the European monetary situation and Miller was concerned about an expectant increase in speculation due to inflation (Wueschner 1999, 136-38). At times, Miller even waivered concerning his own policy (Wueschner 1999, 149). Collective decision-making over the monetary base, absent an explicit rule, yields most often a compromised outcome.[2] Absent a clear rule to guide policy, it is hard to imagine the implosion of the gold standard as anything but inevitable. It is also hard to imagine that investors and entrepreneurs felt confident about expectations regarding policy.
The next draft should be up soon.

[1] Benjamin Strong wrote to Montagu Norman at the Bank of England that without the Federal Reserve “bankers would now be insisting that borrower pay their loans, and, were this to force sacrifice sales of inventories at present quoted prices, we would have a long list of insolvencies, closing mills, unemployment etc.” quoted in Wueschner (1999, 18n89)
[2] Wueschner draws attention to this in reviewing the Federal Reserve’s deflationary policy in 1920:
The outcome, Strong later wrote to Norman, was not at all what he would have recommended, “nor indeed, confidentially, did [it] meet the advice of my associates in the Bank.” It amounted to a “compromise between differing views of our own with differing views in the Federal Reserve Board and finally, radically diferent views held by the officers of the Treasury.”

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