There is just too much good stuff to excerpt from Gerald O’Driscoll’s lead essay at Cato Unbound on central banks. OK fine, here’s just a taste:
Does the literature make an intellectual case for ending the Fed? The 19th century economic journalist and Economist editor Walter Bagehot thought it would have been better if the Bank of England had never been created. In Lombard Street, Bagehot argued that a decentralized system of many banks of approximately equal size would have been preferable. Instead of reserves being concentrated at the Bank of England, reserves in the competitive system of banking would have been dispersed among all banks.
Concentrating reserves at a central bank was the cause, not the cure, for panics. The concentration of reserves exposed the banking system to periodic panics and scrambles for liquidity. Bagehot’s famous dictum that Bank of England must lend freely at penalty interest rates in times of panic was a second-best solution to a problem caused by centralizing reserves in that institution.
Now Scott Sumner responded (in a very polite and scholarly way). You know how I often complain that Sumner is a bit slippery?
Watch this. I’m going to excerpt from Sumner’s article, then make a point about it:
I believe O’Driscoll is overly optimistic about the effectiveness of gold standard regimes. In addition, I would argue that we should avoid policy regimes that are “tamper-proof.” We don’t know what sort of policy regime is best. Therefore we should have policy regimes that are easy to alter in a situation where they appear to be causing grievous economic harm.
O’Driscoll briefly discusses the possibility of combining fiat money and free banking. He ends up concluding that this sort of regime would be too susceptible to political tampering. In my view that’s a powerful advantage of a fiat money regime. Throughout history there are many examples of rigid monetary regimes that went seriously awry and caused great damage before they collapsed. In the early 1930s prices fell sharply under an international gold standard regime. Countries did not begin recovering from the Depression until they abandoned the regime. Argentina suffered from falling prices and nominal GDP in the late 1990s and early 2000s under a rigid “tamper-proof” currency board.
In many respects the eurozone of today is an even more “tamper-proof” monetary regime than a gold standard or currency board regime. It is extremely difficult for an individual country to exit the euro without triggering a collapse of their banking system. The euro is much more than a fixed exchange rate regime. The peripheral economies of the eurozone certainly would have sharply devalued their currencies if they had been able to do so.
So then it becomes a judgment call. How bad are the future mistakes under fiat money likely to be? And how bad might things end up under a rigid monetary regime such as a gold standard? In my view the downside risks from a return to a gold standard, however constituted, are far greater than the risks of persevering with fiat money and trying to make incremental improvements. [Bold added.]
As I hope the bolded statements above make clear, Sumner was not making offhand remarks that his proposal was less “rigid” than O’Driscoll’s. Nope, Sumner was stating it as the reason O’Driscoll was wrong (or at least one of the reasons).
In light of comments such as the ones I quoted above, the editor(s) at Cato understandably titled Sumner’s reaction essay, “In Defense of a Flexible Monetary Policy.” How could anyone possibly object to such a title, right?
Oh wait, Sumner did. On his blog linking to the exchange, Sumner writes: “My only quibble is the title they gave my essay. I favor maximum policy rigidity—the pegging of the price of a NGDP futures contract.”
My point in bringing this up, is I want you Sumner fans out there to realize I’m not merely whining when I say the guy is slippery. I’m not saying he’s a liar, just saying he is slippery. You spend months reading him, to understand his world view and why, for example, you should “never reason from a price change,” and then you’re told that a jump in stock prices proves QE is working. It’s truly why I am not following him as closely as I used to, because I don’t feel that he’s a stationary target.