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Austrians on the Nobel

Mises Daily: Wednesday, October 20, 1999 by

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Mises.org asked leading Austrian economists for their impressions of the 1999 Nobel Prize for Economics, whose winner is Robert Mundell of Columbia University.


Austrians should be very pleased about the awarding of the Nobel Prize to Robert Mundell. More than any other contemporary economist, he was responsible for making discussion of the gold standard respectable once again in academia beginning in the early 1980's. This is despite the fact that Mundell, like all supply-siders, is a big fan of central banks when they operate according to a golden price rule, which, even if it is actually adhered to, mandates credit expansion when the price of gold is declining.

More importantly, he completely and singlehandedly destroyed Keynesian macroeconomics and balance-of-payments analyses by pointing out that Keynesian closed-economy macro models were not only misleading but completely irrelevant in a world of international capital flows. In this respect, his contribution was much greater than Milton Friedman's, whose monetarist approach was developed within the closed-economy framework of Keynesian macro models.

Also, Mundell is wholly responsible for the revival of the monetary approach to the balance of payments and exchange rates. According to this approach, which was the approach not only of Ricardo and the classicals but also of Mises, Hayek and Robbins, the balance of payments and exchange rates were strictly monetary phenomena. This implied that, unless the public was continually reducing its demand for money, if a nation suffered a persistent balance-of-payments deficit or depreciating exchange rate, this could only be the result of a relatively inflationary monetary policy and not of some "structural" real cause.

Finally, although Mundell, in his younger days was a mathematical modeller par excellence, he is not (and was never) a narrow technocrat but a relatively free-market political economist with an intense interest in the operation of real world institutions.

Despite his significant shortcomings in monetary policy (as well as in fiscal policy where he favors tax-cut fueled budget deficits), Austrians should not underestimate his accomplishments in carrying macroeconomics and international monetary theory in a direction that was significantly more congenial to Misesian-Hayekian modes of analysis. I venture to say that, from an Austrian point of view, Mundell is the most deserving recipient of the Nobel Prize after Hayek.


Jeffrey Herbener
Grove City College

Although I agree with Professor Salerno's assessment of the importance of Mundell's work and his conclusion that Mundell's prize ranks with Hayek's in Austrian circles, I’ll concentrate on the dross as well as the silver in his work.

The Wall Street Journal not only claimed Mundell as its leading intellectual, it took the trouble to reprint an excerpt from an article he published in 1990 as its lead op-ed piece. In it Mundell calls for a world central bank. Countries should use their gold hoards to create an international money and to stabilize its value. He implies that the Fed would be the world's central bank and the dollar the world's currency. It is true that he would not want this power to be used for a world-wide credit expansion, which is the dream of the WSJ, but who doubts that once in place, the system would operate this way.

By 1997, his views had changed somewhat. I remember reading his more detailed plan for monetary reform in his St. Vincent paper. Here he claims that gold's role in international monetary affairs cannot be as it was in the nineteenth century (i.e., there is no going back to the classical gold standard). Then, there was a balance of power between the great nations. But now, America is the only super power.

He concludes,

"the most important event of the 20th century was the creation of the Federal Reserve System, the vehicle for the spread of the dollar. Without that, you would not have had the subsequent monetary events that took place. Let us hope that the most important event of the 21st century will be that the dollar and the Euro learn to live together."

He, thus, concedes "super power" status to the EU and an ideal world with two currencies. He also does not rule out the Yen, or perhaps the yuan, as a third.

Whatever else one can make of this, Mundell is not an advocate of the pure, or even the classical, gold standard. Even granting his importance in reintroducing gold into debates about monetary regimes and his role in the demise of Keynesianism, we cannot cheer too loudly for him. Jude Wanniski has a more rightful claim to him and his legacy.

Moreover, as with Hayek, whatever the true level of Mundell's Austrianism (or rather Misesianism), others have already wrung that tradition out of his work. The New York Times seems to think that his international theories sprung, sui generis, from his fertile, Canadian-bred mind. But, as Professor Salerno pointed out, he is merely standing in a long tradition of which Mises was a part. This is not to deter from his marvelous and maybe even courageous application of this tradition in helping to demolish Keynesianism. Unfortunately, no one but Joe will say that in his highest achievement, Mundell was just echoing great economists of the past.

All these caveats aside, I agree that Mundell is about the best laureate Austrian economists can hope for outside our own circles.


Walter Block
University of Central Arkansas

How does Robert Mundell fit into the gold standard picture? Apart from a historical appreciation of gold, his views on present policy are deeply flawed: he rejects the monetization of gold, contenting himself with attempts to bring greater accountability to a system that has long since been wrenched out of the hands of the market, and given over to the tender mercies of the political system.

In his particular case he advocates the "gold price rule" which is similar, in effect and in intention, to Milton Friedman's 3% "rule" for the fed. That is, it is an attempt to obviate government's natural tendency to inflate, without setting up a separation of money and state, as would exist under a pure gold standard.

Mundell is also noted for a general stance in behalf of economic freedom, and for that he deserves credit. But it is his work in the theory of optimal currency areas and his criticisms of floating exchange rates that attracted the attention of the Nobel committee. In particular, he is known for his 1961 article, "Optimal Currency Areas," appearing in the American Economic Review, Vol. 51, Sept., 1961, pp. 657-664. The question he has dealt with is: what geographical zone is appropriate for each type of money?

In his view, the "optimal currency area" is not the whole world. On the contrary, it encompasses far less territory than that. Right off the bat, that puts him in conflict with the gold standard view, which of course sees the optimal currency area for gold as the entire globe.

Thus, not only shouldn't the world be on the gold standard for Mundell; it should not operate on the basis of any one currency, no matter what it is, whether or not it is gold. We need, in his analysis, many currencies. But not competing ones, the Hayekian perspective. Instead, each one should be supreme, within its own area.

How does he arrive at this conclusion? He starts off with an initial assumption of full employment and equilibrium in the balance of payments. Then he posits a shift in demand, say from country B to country A (Mundell, 1961, p. 658). In his Keynesian model, this causes unemployment in B and inflation in A. As a result, there will be a flow of funds from B to A; B will be in balance of payments deficit, A in surplus.

To correct unemployment in B, there should be an increase in its money supply. But this would aggravate inflation in A. So slower or zero monetary growth is indicated there. Or, best of all, a fall in the value of B's currency, and a rise in that of A's. To the unreconstructed Keynesian, this represents no problem at all. With their keen insights into the workings of macroeconomics, money manipulation, fine tuning, flexible exchange rates, all is solved.

Now suppose that the world consisted of only the U.S. and Canada (Mundell, 1961, p. 659). Again, Mundell posits a situation of initial full employment, and balance of payment equilibrium, this time between the different regions of the two countries. As before, he then assumes a shift in demand. This is not from one country to another, but rather from goods produced in the western part of both countries to goods produced in the east.

The analysis flows along familiar channels: as a result of this demand shift, there will be unemployment in the west, and inflation in the east. There will be a flow of bank reserves from west to east. The west will be in (internal) balance of payments deficit, the east in surplus. To correct unemployment in the west, an increase in the money supply would be called for. But this would just exacerbate the inflation in the east.

Unlike the previous case, there is no solution for Mundell: Except, that is, if currency is tailored to regions which are economically significant, not nations, which need not always be. To wit, there is a solution if the east and the western zones each have their own separate currencies. Then, the twin scourges of unemployment and inflation can be solved as they were before, through the use of monetary and fiscal policy and flexible exchange rates.

Having presented this model, let us now consider a few of its drawbacks. First, how is the region to be defined? Mundell does this in terms of a place within which there is factor mobility, and outside of which there is none. But regions so defined continually change. That is, relative prices, new discoveries, innovations, the supply and demand of complements and substitutes are in a continual flux in the real world. If there are to be separate currencies for each region, and the regions keep changing, the implication would appear to be that the currencies, too, should continually be altered.

This, however, appears more as a recipe for chaos than a serious suggestion for a new monetary policy. Further, in one sense government is the main or only source of factor immobility. The state, with its regulations, required specifications, "buy local" requirements, licensing arrangements–to say nothing of explicit interferences with trade–is the prime reason why factors of production are less mobile than they would otherwise be.

In a bygone era the costs of transportation would have been the chief explanation, but what with all the technological progress achieved here, this is far less important in our modern "shrinking world." If this is so, then under laissez-faire capitalism, there would be virtually no factor immobility. Given even the approximate truth of these assumptions, the Mundellian region then becomes the entire globe–precisely as it would be under the gold standard. (Here factor immobility is being defined as essentially government prohibition on trade.)

There is an entirely different sense of factor mobility, however. Lying at the opposite end of the spectrum from the previous one, here it consists of the fact that costs (mainly transportation costs) render factors immobile, geographically. Based on this assumption, each individual person would have to be defined as a separate region. This is so because by definition he is the region within which there is mobility, and outside of which there is none.

What is the implication of this second model? If there are supposed to be as many different types of currencies as regions, and if each person is a region, then there would have to be as many currencies are there are people–a separate type of money for each person. The problem with this, of course, is that it would be the end of money as we know it. A world with six billion different currencies is, in effect, as world with no money at all. Under these conditions we would fall back to a situation of barter.

Mundell himself sees this problem. But rather than shrinking in horror from either scenario (especially the latter) he proposes what all economists in good standing in the neoclassical school would propose–a cost benefit analysis. If the primary goal is economic stability, then the number of currencies should be larger; if it is the use of money as a medium of exchange, then the fewer the different numbers of currencies the better.

So, what is the optimal number of currencies for the world? Mundell does not vouchsafe us a specific answer to this rather important question. Reading between the lines, one gets the feeling that this number should lie for Mundell somewhere in between several dozen to a few hundred, but as he never specifies, this is at best an educated guess.

So far, we have accepted the stability argument; the quaint notion that monetary and fiscal policy can lead us to the promised land. With the best will in the world, monetary and fiscal policy are just not up to the job. Rather than anti-cyclical, bureaucratic interference with the market–whether from fiscal or monetary plannesrs–has been pro-cyclical. Nor can we rely on the best will in the world, for civil servants, not only private entrepreneurs, can be expected to indulge in "rent seeking" at the expense of the public good.

A further problem with the Mundell model is that it is open to a possible reductio ad absurdum rejoinder. At present, no one worries about "balance of payments" problems between New York State and New Jersey. Nor between California and Maine, nor Oregon and Florida. But with the advent of the Mundellian perspective, this would no longer be true. Now, we can add this worry to all the rest which plague mankind.

[A version of this analysis appears in Walter Block article on gold in Managerial Finance, 15-33 of Vol. 25, No. 5, 1999. You can read the working paper version here


Sam Bostaph
University of Dallas

I think that while evaluating the intellectual impact of Mundell's Nobel it is worth bearing in mind that while he applauds markets, he was, is, and will likely remain an interventionist-- advocating government-controlled exchange rates and a government central bank that manipulates interest rates and the money supply, gold exchange standard or not. He also suffers from the belief that (according to the Wall Street Journal), "the best minds that Europe can muster" could run a "successful" monetary policy. But the best minds are never a substitute for market forces.


See also Mundell's comments on gold.