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Greg Ip asks an interesting question

Summary:
David Beckworth linked to this tweet by Greg Ip: 1/ Random thought: maybe we could defeat lowflation by returning to the gold standard – at ,000 per ounce. There are some follow-up tweets. In the late 1990s, I wrote a long paper discussing FDR’s gold buying program, which was an attempt to create inflation by targeting gold at ever-higher prices.  (It’s a chapter in my Midas Paradox book.)  It turns out that this is a very interesting and very confusing issue.  But hey, it’s monetary policy, what else do you expect? The simple answer to Greg’s question is “yes”, for the same reason that Japan could defeat lowflation by pegging the yen at 210 to the dollar, instead of the current 105/$. To simplify things, let’s start with the “small country assumption”.  Lets say the Swiss

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David Beckworth linked to this tweet by Greg Ip:

1/ Random thought: maybe we could defeat lowflation by returning to the gold standard – at $3,000 per ounce.

There are some follow-up tweets. In the late 1990s, I wrote a long paper discussing FDR’s gold buying program, which was an attempt to create inflation by targeting gold at ever-higher prices.  (It’s a chapter in my Midas Paradox book.)  It turns out that this is a very interesting and very confusing issue.  But hey, it’s monetary policy, what else do you expect?

The simple answer to Greg’s question is “yes”, for the same reason that Japan could defeat lowflation by pegging the yen at 210 to the dollar, instead of the current 105/$.

To simplify things, let’s start with the “small country assumption”.  Lets say the Swiss saw this Greg Ip tweet, and were thinking about whether it could help them to achieve higher inflation.  From the Swiss perspective, it would be clear that this policy is basically equivalent to cutting the foreign exchange value of the SF in half, say from roughly one US dollar to roughly 50 cents.  Yes, that would create lots of Swiss inflation, no doubt about that.

[Here I am assuming that gold is currently $1500/oz., and that the Swiss action doesn’t impact the dollar price of gold—i.e. the small country assumption.  That’s why it’s effectively the same as currency depreciation

Could the Swiss successfully depreciate the SF?  Sure, if they offer to sell unlimited SF at the new target exchange rate, then that will become the new effective market exchange rate.  Are they willing to buy enough assets to make this new exchange rate stick?  This is the hard question.  It’s not even clear they’d have to buy any assets, as people might sell SF out of fear of imminent Swiss hyperinflation.

Obviously in the real world the Swiss would not want to depreciate the franc so sharply.  In that case they might have to buy a lot of assets to depreciate the franc.  And that might lead to worries about central bank balance sheet risk.  Now we are back to the longstanding debate about QE.  Not so much “does QE work”—a meaningless question—rather how much do you have to buy in order to assure that QE works?  As long time readers know, I don’t accept the standard view that more expansionary policy regimes require more QE.

The basic point is that pegging gold at $3000 will work, but the things you might need to do to make the peg stick could very well work even without bringing gold into the equation.  You could simply do all the QE without buying any gold.

If you were serious about doing something like this, wouldn’t it make more sense to peg the price of CPI futures contracts, not gold?  After all, we have a pretty good idea as to what sort of CPI futures price is likely to lead to roughly 2% inflation, but we have absolutely no idea as to what sort of gold price is likely to lead to 2% inflation.

If we go beyond the small country assumption, things get more complicated.  The US is so big that an attempt to peg gold prices at $3000/oz. could lead to a sizable increase in the global demand for gold.  In that case, the inflationary impact would be smaller than in the Swiss case, as the real value (i.e. purchasing power) of gold would rise.  Even so, it would still “work” in the sense or raising the price level, just a bit less dramatically.

These are not good policy ideas, but they actually are quite useful thought experiments.  They allow us to better understand the real issues at stake here.

PS.  If we were to return to the gold standard, presumably it would involve a gold price peg that increased by 2%/year.  That would give us the 2% long run trend inflation we seem to want, not the 0% long run trend under a true gold standard.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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