Academic journal article Review - Federal Reserve Bank of St. Louis

Commentary

Academic journal article Review - Federal Reserve Bank of St. Louis

Commentary

Article excerpt

MICHAEL BORDO PROVIDES US with a comprehensive, scholarly study of the history of the three main international monetary regimes: the gold standard, the dollar standard, and the floating exchange rate. He focuses on two important questions. First, which regime provided the best performance with regard to the levels of inflation and real growth? Second, what makes an international monetary regime viable?

Because I am not a historian, I will limit my comments to two areas. I will first discuss the comparative evidence on the performance of the three monetary regimes and use Bordo's statistics to infer a little more information on the role of demand shocks under the different regimes. Thereafter-I will concentrate on the important issue of determining a monetary system's credibility. I find Bordo's thoughtful discussion of the issue useful. I should add, however, that sometimes he takes the literature too seriously--especially the affirmative literature on the European Monetary System (EMS). Nevertheless, Bordo forces us to consider which monetary system or standard, if any, can solve the credibility problem in terms of firmly anchoring market expectations about its viability.

WHICH REGIME PERFORMED BEST?

It is natural to evaluate the welfare implications of monetary regimes by asking what different regimes achieve with respect to the level and stability of inflation and real growth. Any monetary regime can be described as a mechanism or device that delivers an average rate of monetary expansion and a variance of money growth. With respect to economic performance, the essential difference is whether a particular regime provides governments with more or-less freedom to manipulate the average rate of and the variance of monetary expansion. It follows that regime differences should he reflected in inflation levels and variances of inflation and per capita growth.

Table 1 draws from Bordo's tables 1 and 4. I consider the Group of Seven countries as a whole, the United Slates, Germany, and France and concentrate on the three major periods: the pre-World War I gold standard, the Bretton Woods system of the 2950s and 1960s, and the floating exchange rate in place since the mid-1970s.(1) Note that, in contrast to Bordo, I do not separate out the favorable performance of the Bretton Woods convertible subperiod (1959-1970) in terms of inflation and output. The subperiod looked good on the surface; how. ever, it was in fact the period when the break. down of Bretton Woods was programmed. More generally speaking for any regime we might find post a good looking subperiod.(2)

As Bordo and others have pointed out, the data permit the following observations:

* First, average inflation was negligible under the gold standard and highest under the floating exchange rate.

*Second, the variability of inflation, as well as that of real growth, was higher' under the gold standard than under the floating exchange rate.

* Third, the Bretton Woods regime exhibited the highest variability of inflation, whereas output variability was closer to its level under. the float than under the gold standard.

The first observation on average inflation performance is well known and understood. It is widely accepted that the classical gold standard prevented the manipulation of monetary expansion by enforcing a direct link between the base money stock, the national stock of gold and the balance of payments. Though devaluation was possible by raising the gold parity in national currency, it was rare. Thus the gold standard delivered the lowest average rate of inflation, given that the available gold stock did not grow much.

At the other extreme, fiat money cum floating does not put any external constraint on domestic money production. Thus governments are flee to use money production to collect inflation fix and to dampen the business cycle. The additional advantage to governments of the floating exchange rate is that the regime spares them the political cost of negotiating devaluation. …

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