Greg Ip Asks An Interesting Question

Aug. 13, 2019 6:15 AM ETBNDX, GIM, BWX, IGOV, FIXD, DIAL, FLIA, GLBY1 Comment1 Like
Scott Sumner profile picture
Scott Sumner
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Summary

  • 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.
  • 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.
  • 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?

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". Let's 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.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

This article was written by

Scott Sumner profile picture
1.08K Followers
Bio My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.
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