Wednesday, July 24, 2019

Every era’s monetary and financial institutions are unimaginable until they’re real

Every era’s monetary and financial institutions are unimaginable until they’re real, writes Tyler Cowen in an excellent essay on the anniversary of Bretton Woods. (MR link)

Our ancestors' experience with paper money leading quickly to massive inflation would leave them agape at our completely unbacked fiat money and floating exchange rates which has led only to mild inflation. forward [from the gold standard] to the current day. Currencies are fiat, the ties to gold are gone, and most exchange rates for the major currencies are freely floating, with periodic central bank intervention to manipulate exchange rates. For all the criticism it receives, this arrangement has also proved to be a viable global monetary order, and it has been accompanied by an excellent overall record for global growth. 
Yet this fiat monetary order might also have seemed, to previous generations of economists, unlikely to succeed. Fiat currencies were associated with the assignat hyperinflations of the French Revolution, the floating exchange rates and competitive devaluations of the 1920s were not a success, and it was hardly obvious that most of the world’s major central banks would pursue inflation targets of below 2%. Until recent times, the record of floating fiat currencies was mostly disastrous.
As Tyler points out, even 20 years ago the standard opinion was that the euro would not work.
Another surprising monetary innovation would be the euro. Both Milton Friedman and Paul Krugman warned that the euro was unlikely to succeed and persist. Yet it has proven more durable than many people expected, and there does not seem to be an end in sight. This kind of a common fiat currency, spread across so many nations, is without precedent in world history.
(I quibble with that one: Gold coins were an international currency, and throughout history coins have been shared among countries. Our own "dollar" comes from the common colonial use of a Spanish coin.)

The sovereign default issue remains, but that less-than-desired  inflation remains the euros' problem would have been a big surprise. That countries like Greece and Italy would, so far, choose the hard path of staying on the euro rather than take the sugar high of another devaluation is indeed a political if not an economic surprise.

Bretton Woods' system, including fixed exchange rates, the IMF, a dollar sort of pegged to gold but you can't have gold, dollar reserves, and extensive capital controls is as archaic to us as it was radical to pre WWII thinking.

Tyler only hints at the main message:
 Looking forward, don’t assume the status quo will hold forever, but rather prepare to be shocked....
So as you consider the legacy of Bretton Woods this week, remember that core lesson: There will be major changes in monetary and institutional arrangements that no one can even imagine right now. Assume the permanency of the status quo at your peril.
My main point is to underline that hint.

We forget how recent our own monetary certainties are,. Well into the 1970s, mainstream Keynesian economists thought that inflation came from "wage price spirals" and administered prices, and that central banks were pretty irrelevant. Milton Friedman was a radical upstart. He won, dramatically, on the importance of central banks. Yet too his focus on money growth rates died out with the 1980s. The current consensus view that central banks have the power to control inflation, and the power, ability, and duty to stabilize the economy, all by setting short term rates, is an idea that only took shape in the late 1980s and 1990s.

And that is falling to pieces all around us. That no "deflation spiral" breaks out at the zero bound undermines that view entirely. The death of the Phillips curve, the antithesis of the 1970s -- strong output and employment with puzzlingly low inflation -- the endless inflation below central bank targets, all stand witness. (And be careful what you wish for! Strong growth with low inflation is pretty darn nice!)

Intellectually, we grope to maintain the illusion of an all-powerful central bank, whose asset purchases and Delphic pronouncements about its future actions powerfully steer the economy. But the feeling that perhaps Friedman won too much, and that central banks are not nearly as powerful as they seem (other the power to screw things up, which they retain!)  is getting stronger and stronger.

The only thing that is sure is that our current doctrines will look as archaic 20 years from now as Bretton Woods, and the 1950s-60s Keynesian consensus, do today. That humility -- and the hard and and critical thinking it ought to provoke -- are indeed great lessons of this anniversary.

Every era’s monetary and financial institutions are unimaginable until they’re real. And so will be the next era's institutions.


  1. It sounds like you are not a fan of the market monetarist view! Have you published an explanation of your views there that would be worth reading?

  2. In many ways this is one Cochrane's most enervating posts.

    Highly intelligent and well-informed economists may hold beliefs dear and true, and which are vociferously argued, but which are abandoned for new ones, perhaps more than once in a life time.

    I am reminded that the very smart, highly regarded Martin Feldstein spend decades warning of higher inflation and interest rates pending, with a hint of doom in his outlooks. For that matter, so did and has Paul Volcker.

    Perhaps in my lifetime I will see the embrace of money-financed fiscal programs.

    What makes more sense: trying to stimulate the US economy by pushing on various levers and gadgets inside the supremely unwieldy Federal Reserve and global commercial banking and capital system...or cutting taxes on wages on domestic residents, offset by Treasury issuing and central bank buying of bonds? Or dispense with the bond-buying-selling, and just have the Treasury print money to offset tax cuts on people who will spend their own earnings.

    I wonder what causes inflation.

    Heresy? Well...the idea of the Bank of Japan buying back half that ntion's heroic Mt. Everest pile of JGBs, pegging interest rates at zero, running national budget deficits and hitting nearly zero inflation would have been heresy when I went to school (which was after my college campus was wired for electricity). All this when there are 162 job opening per job hunter in Japan.

  3. The word "dollar" even pre-dates the colonial usage! It comes from the 16th century Bohemian coins called "joachimsthalers," named after the mine at Joachimsthal.


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