Far from being synonymous with stability, the gold standard itself was the principal threat to financial stability and economic prosperity between the wars.” Barry Eichengreen, Golden Fetters.
The extraordinary monetary easing engineered by central banks in the aftermath of the 2007-09 financial crisis has fueled criticism of discretionary policy that has taken two forms. The first calls for the Federal Reserve to develop a policy rule and to assess policy relative to a specified reference rule. The second aims for a return to the gold standard (see here and here) to promote price and financial stability. We wrote about policy rules recently. In this post, we explain why a restoration of the gold standard is a profoundly bad idea.
Let’s start with the key conceptual issues. In his 2012 lecture Origins and Mission of the Federal Reserve, then-Federal Reserve Board Chair Ben Bernanke identifies four fundamental problems with the gold standard:
- When the central bank fixes the dollar price of gold, rather than the price of goods we consume, fluctuations in the dollar price of goods replace fluctuations in the market price of gold.
- Since prices are tied to the amount of money in the economy, which is linked to the supply of gold, inflation depends on the rate that gold is mined.
- When the gold standard is used at home and abroad, it is an exchange rate policy in which international transactions must be settled in gold.
- Digging gold out of one hole in the ground (a mine) to put it into another hole in the ground (a vault) wastes resources.
Consistent with Bernanke’s critique, the evidence shows that both inflation and economic growth were quite volatile under the gold standard. The following chart plots annual U.S. consumer price inflation from 1880, the beginning of the post-Civil War gold standard, to 2015. The vertical blue line marks 1933, the end of the gold standard in the United States. The standard deviation of inflation during the 53 years of the gold standard is nearly twice what it has been since the collapse of the Bretton Woods system in 1973 (denoted in the chart by the vertical red line). That is, even if we include the Great Inflation of the 1970s, inflation over the past 43 years has been more stable than it was under the gold standard. Focusing on the most recent quarter century, the interval when central banks have focused most intently on price stability, then the standard deviation of inflation is less than one-fifth of what it was during the gold standard epoch.
Money and Banking
Gold Standard Explained With Its Pros and Cons
The gold standard makes countries obsessed with keeping their gold. They ignore the more important task of improving the business climate. During the Great Depression, the Federal Reserve raised interest rates. It wanted to make dollars more valuable and prevent people from demanding gold. But it should have been lowering rates to stimulate the economy.
Government actions to protect their gold reserves caused significant fluctuations in the economy. In fact, between 1890 and 1905, the economy U.S. economy suffered five major recessions for this reason. Edward M. Gramlich mentioned these facts in his remarks at the 24th Annual Conference of the Eastern Economic Association on February 27, 1998. Gramlich is a former member of the Board of Governors of the Federal Reserve.
A fixed money supply, dependent on gold reserves, would limit economic growth. Many businesses would not get funded for lack of capital. Furthermore, the United States could not unilaterally convert to a gold standard if the rest of the world didn't. If it did, everyone in the world could demand that the United States redeem their dollars with gold. American reserves would be quickly depleted. Defense of the United States’ supply of gold helped cause the Great Depression. The Great Depression ended when Franklin D. Roosevelt launched the New Deal.
The Balance.com
“Anywhere you look, the problems of using the gold standard are described the same. One thing, the money is limited to the amount of gold a country has, not the resources or the know-how of the people. That would be a waste.”
ReplyDeleteFortunately no nation has ever really had a “gold standard.” There was only a pretense, a gimmick used by politicians when they wanted to claim that there was “no money” for something the public wanted. Meanwhile there was (and is) infinite money for things like World War.
Debating the “gold standard” is as silly as arguing about how many unicorns exist in the world. The "gold standard" has never existed, and if it were ever enacted, it would be economically disastrous.