Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

The Case for a Monetary Rule in a Constitutional Democracy

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

The Case for a Monetary Rule in a Constitutional Democracy

Article excerpt

Constitutional democracy protects individual liberty. It does so by placing restraints on the arbitrary exercise of power by government. A primary restraint is the constitutional protection of property rights. The monetary arrangements of a country either promote or undermine that protection.

Money is unique in that its value in exchange far exceeds the cost of producing an additional unit. On the one hand, governments have an incentive to print additional money to gain "free" resources, or seigniorage revenues. 1 On the other hand, the central bank must limit the quantity of money in circulation to control prices.

Through its influence on seigniorage, money creation affects how government raises revenue. It can also affect who within government decides how that revenue is spent. Through its influence on fluctuations in the price level, money creation influences the extent of arbitrary redistributions of wealth among individuals. The institutional arrangements that govern the creation of money then bear on two aspects of the protection of property rights: the taking and disposition of wealth from the public and the distribution of wealth by government between individuals.

A legislative mandate from Congress requiring the Federal Reserve (the Fed) to stabilize the price level and to hold only government securities in its portfolio would complement the rules in a constitutional democracy that protect property rights.

A Financial Times (1990) editorial made the case for rules in the conduct of monetary policy:2

The notion that money must fall within the domain of day-to-day politics is a 20th century heresy.... Painful experience with the modern manipulation of monetary policy suggests that money is more appropriately an element of the constitutional framework of democracy than an object of the political struggle. Monetary stability is a necessary condition for a working market economy, which is itself a basis for a stable democracy.


Sections 2 and 3 provide historical background showing that monetary arrangements in Britain and the United States have in the past raised issues basic to the design of a constitutional democracy. Early British experience influenced American thinking during the Revolutionary War, in which protection of property rights was a central issue. Section 3 reviews how during the period of the Articles of Confederation the states' discretionary control of money undermined property rights. The monetary abuses of this period contributed to the convening of the Constitutional Convention.

Section 4 reviews the more recent experience with discretionary control of inflation in the 1970s and argues that this experience produced the same arbitrary redistributions of wealth that characterized the earlier period. The earlier experience led the Founding Fathers to remove government discretion over money creation by putting the United States on a specie (gold or silver) standard. The later experience caused the Fed in practice to assign priority to maintaining a low rate of inflation. However, in this more recent period, the United States has not put in place institutional arrangements to ensure monetary stability in the future. Section 5 reviews fiscal transfers by the Fed made possible through seigniorage and discusses how they can circumvent the constitutionally mandated budget process. Section 6 offers concluding comments.


The following historical review provides examples of how monetary arrangements either reinforce or relax constitutional constraints on the exercise of power by government. Discretionary control over inflation can undermine the accountability provided for in a constitutional democracy. The power of a government to increase the revenue from seigniorage through inflation without explicit legislation lessens democratic accountability. Moreover, the ability to allocate seigniorage revenues discretionarily, that is, outside the constitutionally mandated budget process, lessens accountability. …

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