The Politics of Monetary Policy
[This article is excerpted from chapter 3 of Politically Impossible?]
Suppose an economist is convinced that the most appropriate international monetary system in a civilized age is one in which the measuring rod of money in every country has a common, defined value; and, further, that the ideal money unit in such a system will have a value consistent with stability in a price index weighted, as far as practicable, so as to give equal proportionate importance to all components of real income (the flow of productive services). He could at the same time hold that, governments and politics being as we know them to be in the present century, the old-fashioned gold standard would be a more expedient system solely because, under the kind of convertibility obligation that standard requires, politicians in office could be subjected to a simple understandable monetary discipline.
In thus recommending, he would be candidly admitting the inferiority of the gold standard for an imaginary or predictable future era, in which the propensities of governments to manipulate the value of the money unit in the interests of election winning had been constitutionally overcome. He would be saying, in effect,
Because we have not yet reached such high standards of electoral wisdom or of integrity in government, we have to be content with the second-best solution. Given current realities, the practical way to achieve greater order in international monetary relations would be a return to the pre-1914 gold-standard system. That would, at any rate, render "politically impossible" the creeping, crawling, chronic inflation that has plagued mankind since the 1930s.
It is important to emphasize that, in taking such a line, the economist would not allow his readers to accept the current myth that inflation is a scourge that governments try, with varying success, to keep in check. Yet this very myth, accepted by the critics of governments as well as by governments themselves, is one of the consequences of economists generally failing to make explicit their assumptions about the vote-acquisition process.
Let us now imagine the economist going further and contending that, because the world's governments have not yet re-embraced those standards of responsibility and integrity that caused the gold standard of pre-World War I to operate with such fantastic success, he cannot recommend any return to it. He might then argue,
The best that can be hoped for is something like the present system of an International Monetary Fund with Special Drawing Rights [SDRs]; for this does not call upon governments to abandon the use of monetary policy in election winning, and they are not likely to renounce that. Indeed, no government in power could dare do so because the opposition could make too much political capital out of the unpopularity of noninflationary coordination of economic systems during threatened recession.
Analysis of monetary policy, as a branch of an economics in which governmental activity is viewed realistically as interwoven with market activity, must explicitly and repeatedly stress the connection between the value of the money unit and the vote-acquisition process.
But we can now imagine the economist going still further and arguing,
Even the present IMF system with SDRs is not adequately adjusted to the vote-acquisition realities of this age. The yield in votes to creeping inflation tends to decline as public skepticism grows about a government's commitment to a doughty endeavor to fight off the inflationary dragon. Inflation loses its coordinative power in proportion to the extent to which it is expected; when it is expected, the depreciation of the money unit, however expertly engineered, fails to prevent layoffs and unemployment; the rentier fails to be specially exploited because interest on bonds rises, perhaps to twice the yield on equities, providing thereby as good a hedge against inflation as is available to the investor in shares; while under fixed exchange rates, declining activity causes external pressures for deflation or forces unpopular steps to bring about price-cost adjustments, due to a worsening in the balance of payments.
The situation eventually compels resort to a proliferating bunch of "controls" applied to the remnants of the free-market system. The "controls" all tend to repress productivity and all have a regressive incidence. We can, for instance, expect exchange controls, import controls, such abominations as the United States "interest equalization" law,1 and eventually "incomes policies" with extra-legal governmental coercions or "persuasions" and the imposition of legally enacted wage-rates and prices on the coordinative mechanism of the market.
This way of keeping prices down will normally be preferred by governments to neutral restraints via noninflationary monetary policy; for the particular prices or wage rates to be repressed can be selected in such a manner as to minimize the prospective loss of votes. The propensity of governments to act in these ways, especially when balance-of-payments pressures grow, can be lightened by resort to floating exchange rates. Governments can then follow "a policy of benign neglect" of parity considerations and save themselves a host of worries about inflation consequences. This solution is certainly a lesser evil when compared to such evils as exchange control, import quotas, and all the other paraphernalia for the collective overruling of remaining free-market values. In itself, it enables a continuous market valuation of currencies influenced by the independent inflations which national monetary autonomy permits.
The chief obstacle that makes floating exchange rates appear "politically impossible" is the pigheadedness of certain officials and bankers who are today acting as unreasonably as the officials and bankers who resisted currency debasement in the 1930s. But they were at last overruled then and they can be overruled again. Let the value of currencies be determined in a surviving free market, with no governments having to be shackled by monetary contracts with the world in their essential vote-acquisition function.
Of course, floating exchange rates involve the sacrifice of the benefits of better-coordinated international economic activity. The abandonment of contractual relationships between national currencies has to be deplored in itself. But every "politically palatable" alternative is even worse.
If economists who have advocated a return to the gold-standard system, or adoption of the SDRs under the IMF, or floating exchange rates, had throughout put their case in these realistic terms, continually reminding the opinion-making agencies of the underlying vote-gaining assumptions, the consequences upon policy of that form of exposition could have been profound.
Solutions explicitly stated but rejected on political grounds would not for that reason have remained impotent. The creators of public opinion would have begun to perceive more clearly that the interests of the small group of private people who form governments, or of those conspiring to replace them, or of those who finance their election campaigns, have unduly dominated policy.2 That is, if tacit assumptions about political considerations had been replaced by explicit assumptions, the ultimate reaction on voting conduct could have been diametrically different.This article is excerpted from chapter 3 of Politically Impossible?
- 1. Under "interest equalization," Americans investing outside the United States are taxed heavily, e.g., 15 percent of the capital in the case of investment in equities.
- 2. The incentives that actuate politicians are no less difficult to discipline in the social interest even if they are frequently nonpecuniary and public spirited. In his study of 14 Canadian prime ministers, Mr. Bruce Hutchison remarks that, "with two exceptions," all "were animated by … an insatiable appetite for power," yet "none profited financially from his office" (from the introduction of MacDonald to Pearson: The Prime Ministers of Canada, Don Mills, Ontario: Longmans Canada Ltd., 1967). Even so, Mr. Hutchison has to show that corrupt motives were endemic among Canadian legislators. Thus, although Prime Minister Wilfrid Laurier "remained a poor man, the Liberal machine" he headed "was demonstrably corrupt"(ibid., p. 69), and Prime Minister William Lyon Mackenzie King also "led a party convicted of graft" (ibid., p. 133).
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