Sonin, Konstantin

English

Policy Documentation Center

  
 
Against the Gold Standard 
A lot of simplistic ideas for solving complex problems become popular during economic crises.
One such proposal is for Russia to adopt the gold standard -- that is, to print only as much
money as the Central Bank holds in its gold reserves. Such talk is fraught with serious risks.
Recall the 1930s, when countries that tied their currencies to gold quickly yielded to the ruinous
temptation of protectionism. Nonetheless, the same idea has now grabbed the attention not only
of the Russian media, but of top government advisers as well. 
There are two basic economic arguments against the gold standard. The first holds that
monetary policy is too important a tool for smoothing fluctuations in the aggregate demand.
Easing monetary policy cannot affect "real" economic variables, such as the level of industrial
output and unemployment in the long term. But it can have an impact in the short term as long
as firms and individuals that have not yet adapted their expectations to the reality of rising
prices. If monetary authorities are certain that they can stop printing money after a while, such a
move can indeed help in a recession. But adhering to a gold standard does not allow for
conducting countercyclical monetary policies. The overall volume of currency is determined by
the amount of gold held by the Central Bank, and the ruble-to-gold exchange rate is
permanently fixed at the moment when the gold standard is first adopted. At the same time, the
inflexibility of the gold standard -- that is, the inability to arbitrarily print money and thereby
conduct an active monetary policy -- is also its greatest advantage. As long ago as the 1960s,
U.S. economists (and future Nobel laureates) Milton Friedman and Edmund Phelps argued in
their works that when an economic entity is expecting high inflation, monetary policy loses
almost all of its meaning since issuing more money only leads to higher prices. The gold
standard might help in putting a halt to inflation by not allowing the monetary base to grow.
 
In one sense, the second argument against implementing the gold standard is only a
continuation of the first. But it also took the work of a number of outstanding minds, including
economists Finn Kydland and Edward Prescott (also Nobel prize winners) and their followers in
modern political economy and macroeconomics, regarding stagflation of the 1970s to enunciate
the argument clearly. The usefulness of the gold standard is limited by the fact that no
government in the world can make a commitment not to abandon it in the future. This is
especially true because it often requires not only a firm commitment from a politician or political
party, but also from a future government. But if this were possible in principle, a commitment to
many other forms of monetary policy would work as well. 
 
Of course, the gold standard does have its charm. The classic article "The Gold Standard and
the Great Depression" by Barry Eichengreen and Peter Temin describes how difficult it was for
state leaders prior to the Great Depression to reject the "gold mentality" -- even when it became
obvious that the gold standard itself was creating problems. Nonetheless, the question of
monetary policy is really an issue of the people's faith in the government, and there is no
magical elixir that can help create this. 
 
 
Konstantin Sonin, a professor at the New Economic School/CEFIR, is a columnist for
Vedomosti.  
 
23 April 2009 
 
 
© Copyright 2007. The Moscow Times. All rights reserved.  
 


Against the gold standard

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