Anybody who follows my blog will know that I am not a great fan
of the gold standard or any other form of fixed exchange rate
policy. However, I am a great fan of policy rules that reduce
monetary policy discretion to an absolute minimum.
Central bankers' discretionary powers should be constrained and
I fundamentally share Milton Friedman's ideal that the central bank
should be replaced by a "computer" - an automatic monetary policy
Admittedly, a gold standard or for that matter a currency board
set-up, reduce monetary policy discretion to a minimum. However,
the main problem in my view is that different variations of a fixed
exchange rate regime tend to be pro-cyclical. Imagine for example
that productivity growth picks up for whatever reason (for example
deregulation or a wave of new innovations).
That would tend to push the country's currency higher. However,
as the central bank is keeping the currency pegged, a positive
supply shock will cause the central bank to "automatically"
increase the money base to offset the appreciation pressures (from
the positive supply shock) on the currency.
Said another way, under any form of pegged exchange rate policy,
a supply shock leads to an "automatic" demand shock. A gold
standard will stabilize the currency, but might very well
destabilize the economy.
Hence, the problem with a traditional gold standard is not that
it is rule based, but that the rule is the wrong rule. We want a
rule that provides nominal stability - not a rule which is
Merging Fisher and Hetzel
More than a 100 years ago Irving Fisher came up with a good
alternative to the gold standard - his so-called
Compensated Dollar Plan
. Fisher's idea was that the Federal Reserve - he was writing from
a US perspective - basically should keep the US price level stable
by devaluing/revaluing the dollar against the gold price dependent
on whether the price level was above or below the targeted level.
This would be a fully automatic rule
it would ensure nominal stability. The problem with the rule,
however, is that it's not necessarily forward-looking.
I suggest that we can "correct" the problems with the
Compensated Dollar Plan by learning a lesson from Bob Hetzel. Has I
have explained in an earlier
, Bob Hetzel has suggested that the central bank should target
market expectations for inflation based on inflation-linked bonds
(in the US so-called TIPS).
Now imagine that we merge the ideas of Fisher and Hetzel. So our
is the gold price in dollars and our
ultimate monetary policy goal
is for example 2-year/2-year break-even inflation at for example
the Federal Reserve would announce that it would buy or sell gold
in the open market to ensure that 2-year/2-year break-even
inflation is always at 2%. If inflation expectations for some
reason moves above 2%, the Fed would sell gold and buy dollars.
By buying dollars the Fed automatically reduces the money base
(and import prices for that matter). This will ultimately lead to
lower money supply growth and hence lower inflation. Similarly if
inflation expectations drop below 2% the Fed would sell dollars
(print more money), which would cause actual inflation to
One could imagine that the Fed implemented this rule at every
FOMC meeting and, instead of announcing a target for the Fed funds
rate, would announce a target range for the dollar/gold price. The
target range could for example be +/- 10% around a central parity.
Within this target range the dollar (and the price of gold) would
fluctuate freely. That would allow the market to do most of the
lifting in terms of hitting the 2% (expected) inflation target.
Of course I would really like something different,
Obviously this is not my preferred monetary policy set-up and I
much prefer NGDP level targeting to any form of inflation
would first of all seriously reduce monetary policy discretion. It
would also provide a very high level of nominal stability -
inflation expectations would basically always be 2%. And finally we
would completely get rid of any talk about using interest rates as
an instrument in monetary policy and therefore all talk of the
liquidity trap would stop. And of course there would be no talk
about the coming hyperinflation due to the expansion of the money
And no - we would not "manipulate" any market prices - at least
not any more than in the traditional gold standard set-up.
Now I look forward to hearing why this would not work. Internet
Austrians? Gold bugs? Keynesians?
PS: I should say that this post is not part of my series on Bob
Hetzel's work and Bob has never advocated this idea (as far as I
know), but the post obviously has been inspired by thinking about
monetary matters from a Hetzelian perspective - as most of my blog
PPS: Obviously you don't have to implement the Fisher-Hetzel
Standard with the gold price - you can use whatever commodity price
A Long Look At Productivity And The Stark Reality