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Austrians on the Nobel

October 20, 1999

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

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

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
, 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
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.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

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