Greg Ip asks an interesting question

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”.  Lets 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.


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14 Responses to “Greg Ip asks an interesting question”

  1. Gravatar of George George
    13. August 2019 at 04:10

    https://i.imgur.com/Ije5zZW.jpg

    Vote Democrat or else you’re a bigot.

    Don’t criticize Democrats putting illegal immigrants above American citizens, or else you’re a white supremacist.

  2. Gravatar of George George
    13. August 2019 at 04:12

    https://twitter.com/TeamTrump/status/1160934995642540032

    Fake News will have you believe the electorate is roughly 50/50.

    To trick the population into believing the Demokkkrat Party is something other than a criminal network whose puppet masters control 90% of “MSM”.

    Operation Mockingbird.

  3. Gravatar of George George
    13. August 2019 at 04:19

    POTUS doesn’t even need to participate in Demokkkrat ‘debates’ to win them. lol

    https://twitter.com/ARmastrangelo/status/1156810189993062400

  4. Gravatar of George George
    13. August 2019 at 04:27

    Remember that time the liberal sheep accused others of believing in ‘tin foil hat conspiracy theories’, yet they believed in the mother of all conspiracy theories, the ‘Russia Collusion’ hoax for over 2 years because Fake News told them to believe it?

    https://twitter.com/ARmastrangelo/status/1154064672443817984

  5. Gravatar of Michael Rulle Michael Rulle
    13. August 2019 at 05:24

    I read your Essay on Econlog. I have mentioned that gold could work——or fiat could work——anything can work. And we know, as you have stated, bad or good policy (also bad regulation—different than Fed Policy—-but maybe influenced by them) can happen under any type of “money”. Once the various mechanisms are learned——good or bad policy can happen. I do like NGDP because it is more direct. And if the Fed has the ability to target that beside merely buying and selling futures, and since you say they do, I believe you.

    The Market’s actions indicate fear of slowdown. I saw a July 24 post by John Cochran showing that the “market is bad at forecasting Fed moves”. I didn’t have the 50 hours to analyze his assertion —-although factually it looked accurate even if (I was able).

    But I did wonder if the headline should have been “Fed ignores Market at its own Peril”. He seemed to view the issue of how markets cannot predict prices. But Fed prices are not exactly market prices.

  6. Gravatar of Derrick Derrick
    13. August 2019 at 06:08

    “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.”

    Scott – Would this be the government or Fed which would be bidding up the price of futures? Would those entities be enough to make it “stick”?

  7. Gravatar of George George
    13. August 2019 at 08:18

    ARGENTINA: Proud socialist Argentina’s stock market collapses by 48% and their Argentine peso loses 15% of it’s value BOTH IN ONE DAY after a strong primary showing by extreme left candidate.

    https://i.imgur.com/XKKpHMT.jpg

    Blog author: “Let’s hope the Democrats win in 2020”

    So that we too can experience an economic collapse!

  8. Gravatar of George George
    13. August 2019 at 08:22

    Cue the racist liberals thinking, and some even saying, “Uncle Toms”

    https://mobile.eurweb.com/2016/08/11/entire-black-church-charlotte-endorsing-donald-trump-watch/

  9. Gravatar of ssumner ssumner
    13. August 2019 at 08:31

    Derrick, The Fed. And yes, they have unlimited ability to “make it stick”.

  10. Gravatar of BC BC
    13. August 2019 at 09:05

    “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.”

    Why not choose a variable gold price peg, where the Fed would target a gold price that was expected to produce 2% inflation for the year? How would the Fed do that? By looking at CPI futures. If CPI futures were indicating less than 2% inflation, increase the gold price target. If CPI futures were indicating more than 2% inflation, decrease the gold price target. Better yet, choose the gold price target expected to produce steady NGDP growth! That would give us the Market Monetarist Gold Standard.

  11. Gravatar of Jeff Jeff
    13. August 2019 at 10:37

    I know that Scott knows all about this, but I urge his readers to look up Irving Fisher’s Compensated Dollar Program. Fisher’s program was a gold standard wherein the amount of gold in each dollar was changed at frequent regular intervals to target a broad price index. If prices were too high, the amount of gold in a dollar would be increased, i.e., the official price of gold would be lowered. Doing so would lead people to redeem dollars for gold, lessening the money supply and driving down the general price level. The opposite would happen when prices were too low.
    The beauty of the compensated dollar program is that the target doesn’t have to be a broad price index. It could be something like Nominal GDP, or an Expected Nominal GDP derived from NGDP futures prices. The idea is to use passive convertibility into and out of gold at a target-driven price as the mechanism to adjust money supply.

  12. Gravatar of Derrick Derrick
    13. August 2019 at 11:10

    What if we were to peg the rate to baby bonds? Its a bit of a proxy for humans, but the concept is the same, and utilizing an instrument that people are already familiar with(bonds). The metrics for pricing would be based on that year’s cohort, and would depend on health, education, economic mobility etc.

  13. Gravatar of ssumner ssumner
    15. August 2019 at 07:54

    BC and Jeff, Yes, that’s better. But then why bring gold into the policy regime at all?

  14. Gravatar of Jeff Jeff
    16. August 2019 at 15:54

    Scott, I’m not advocating for a gold standard. I’m only saying that if somebody insists on a gold standard, then something like Fisher’s program is the most sensible gold standard proposal I’ve run across.

    The gold standard has been described as the practice of digging up gold in Africa, issuing paper money backed by it, and then burying the gold at Fort Knox. This is very inefficient in that real resources are used to mine the gold. Bitcoin has the same problem. Fiat currency is nearly costless to produce.

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