Economics, Monetary Policy

Prof. Bernanke teaches wrong lesson on gold standard


Federal Reserve Chairman Ben Bernanke on Tuesday took aim at proponents of the gold standard, saying that such a system handicaps the government’s ability to address economic conditions.

Bernanke spoke in the first of a series of four public lectures at George Washington University that is the central bank’s latest effort to counter a raft of negative public sentiment that has arisen from its handling of the financial crisis. The former Princeton economics professor delivers a second lecture on Thursday and two more next week.

“Since the gold standard determines the money supply, there is not much scope for the central bank to use monetary policy to stabilize the economy,” Bernanke said. “Under a gold standard, typically the money supply goes up and interest rates go down in a period of strong economic activity – so that’s the reverse of what a central bank would normally do today.”

Bernanke talked about the gold standard in a way much different than its proponents do. Here’s John Tamny of Forbes:

To begin, Bernanke observed that to maintain a gold standard would require the discovery of more of the metal itself; essentially that we don’t have enough gold for a standard. The problem with this assertion is that in the same speech Bernanke acknowledged that the Bank of England in the 19th century defined the pound in terms of gold, and did so with gold in its vaults that was a very small percentage of total pounds in circulation.

To put it plainly, the U.S. Treasury or the Fed could give the dollar a stable gold definition with little to no gold backing. If the standard were thought to be credible, as was England’s long ago, there would be very little demand for gold in exchange for currency. Gold can’t earn interest, while currency can. Bernanke’s dissembling about gold supplies existing as a barrier to the shedding of floating money comes off as dishonest in light of his own knowledge of central banking history.

Tamny ably sums up the modern gold standard argument as it is, not as the distorted Bernanke version. Definitely worth a read.

During that speech, Bernanke also said the Fed was not responsible for the financial crisis. Interestingly, however, a new study from a visiting scholar at the Dallas Fed seems to suggest otherwise:

We do find significant evidence that rising real income and falling interest rates are important determinants of credit booms. This evidence is more consistent with the alternative story of Borio and White (2003) attributing credit booms and crises in the past three decades to the Great Moderation which created a benign environment conducive to rising credit. It is also consistent with other empirical work that covers the period 1960-2002 (Mendoza and Terrones, 2008). The negative and significant relationship of short-term interest rates and credit growth may also be consistent with the story of for example Taylor (2009) or Meltzer (2010) who attribute the U.S. housing boom to expansionary policy by the Federal Reserve in the early 2000s in an attempt to prevent perceived deflation. Moreover, housing booms and busts in other countries did not reflect redistributive housing policy. In the period before the Great Moderation they occurred during episodes of expansionary monetary policy. Regardless of whether the Borio and White story or a simpler monetary policy story is the true explanation for credit booms that lead to financial crises it now seems fairly clear from our examination of the data that neither have much to do with rising income inequality

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