Tuesday, December 15, 2009

The gold standard as a commitment technology

The Gold Standard is now part of economic history, and the only times your hear it proposed as a viable monetary regime is on delusional websites put together by people who seem to have found the solution to all of the world's problems in monetary policy. And there are those that believe that gold is the safest asset out there and thus money should be based on it (and one should first question why gold has any value in the first place). So, the Gold Standard is basically a non-starter in the profession nowadays.

Thus, one should highlight the courage of Elisa Newby for looking at the Gold Standard as a possible monetary regime in modern times, and for doing some serious work. Her idea is that the Gold Standard can act as a commitment device, which is particularly useful when monetary policy needs to be significantly relaxed for a while, like during a war or a major economic crisis. As long as it is clear that the monetary authority will return to the Gold Standard, economic agents will continue to trust the local currency even if its gold parity has been suspended. But if the old standard is not reestablished, then the monetary authority has completely lost credibility, and thus will endogenously choose to adhere to the old parity. Note that this also solves the time consistency problem.

Does this mean the Gold Standard is a perfect monetary policy? Note that in this example, it is really effective when it is not applied. But in normal times, it is still subject to all the flaws that lead to its demise.


Agent Continuum said...

Missing word in "then the monetary has completely lost credibility".

AS said...

WSJ online, delusional year round: http://online.wsj.com/article/SB10001424052748704342404574575761660481996.html

Economic Logician said...

AC: corrected, thanks.