The Fed vs. the gold standard: Tyler Cowen nails it

Monetary economics confuses just about everybody, including economists.  But I hope it will confuse a lot fewer people now that Tyler Cowen has given us 68 minutes of his time to explain it in the most concise and accurate fashion I've ever come across.  I listened to the interview yesterday (Russ Roberts questioning Cowen), and plan to listen to it again today. 

The first 45% of the interview is about the Fed: mistakes it has made in the past, how it's been performing in recent decades, why its discount rate is essentially ineffective, why its (target) fed funds rate is THE KEY to monetary policy, and why an inflation target of 2%-3% is just about optimum. 

The next 45% of the interview is about fiat money vs. the gold standard.  On the objectivity scale, I rate Cowen in the top 1% (and Roberts, too, for that matter); Cowen explains in easy-to-understand language why a gold standard would make little or no sense, and why our fiat money system, managed by the Federal Reserve, is working just fine, thank you very much.  I hope Ron Paul and his Fed-bashing supporters listen to it, even if they decide not to admit they did. 

The last 10% is about the political economy of monetary policy.  Politics is always in the picture, isn't it?

Here's the link: Cowen on Monetary Policy, at Russ Roberts's EconTalk website. 

The whole interview is the best 68 minutes you could spend if you're the least bit interested in (but slightly confused by) how our money system works.  Russ Roberts is a maestro at conducting objective interview sessions on timely economics topics, and whenever his opinion differs from that of his interviewee, he has always known how to disagree without being disagreeable.  That is a rare talent, in case you haven't noticed from your web surfing.  I hope Russ keeps up his EconTalk effort indefinitely; he deserves some kind of award for this valuable project.

Lastly, don't miss Tyler Cowen's blog, Marginal Revolution, if you haven't been there before. 

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End note: The power of "belief preservation"

I seriously doubt that Cowen's levelheaded, objective debunking of the gold standard idea will have much impact on anyone who is committed to preserving their chosen belief that the Fed is a sinister conspiracy, and that replacing the gold standard with fiat money was a tragedy.  Reason: "Belief Preservation" is one of the most powerful psychological forces going, and it affects all of us in varying degrees.  Belief preservation is resistance to change.  It's when we make up our minds—then subsequently spend inordinate amounts of mental energy fighting off any challenges to the mental commitment we've made, by taking in all evidence and arguments confirming our belief, and by ignoring evidence and arguments to the contrary.  It affects political blogs, left-leaning and right-leaning economics blogs, and just about anyone who has ever analyzed a problem and drawn a conclusion.  Belief preservation is especially powerful when we've made a commitment, in public or in writing, to a specific conclusion.  [Think which presidential candidate you're for—then try to think how big of a fall-campaign gaffe it would take to change your mind if your candidate won the nomination.  It would have to be a huge one—highly unlikely at that stage—and that's largely due to belief preservation.] 

That's why, even if Ron Paul and his supporters do listen to the Tyler Cowen interview, I do not expect many of them to admit it.  That's okay with me; I'd be happy if it just keeps them bottled up a little tighter in their conspiracy forums, and reduces the number of Fed-bashing sermons posted here in my comments section.

[My position on the gold standard is summarized at the bottom of this article.  Two different definitions of "inflation" are discussed in this article.]

Comments

[General Public]

when “Tokens” are used as “medium of exchange” it’s value has to be assured by the issuer. People cannot live by eating paper or gold what they need to live is food/fuel/energy so when there is a scarcity of these, people will not accept “tokens” unless the issuer assures value by having a reserve of food/fuel/energy.

Reserve banks should have food/fuel/energy reserves to be called reserve banks.

read more >>
http://www.pointbite.com/2008/01/09/food-as-money/

[Objectivist Bill]

I don't see how going back to a Gold Standard is even possible. A little Wikipedia research shows that the US gold reserve is 8133.5 tonnes, or 261.498 million troy ounces; M1 is currently $1346 billion. So even if we make only M1 convertable, gold would have to be valued at just over $5147.00 per ounce.

[PseudoNoise]

Thanks for posting this, seems right up my alley!

[Don Lloyd]

Steve,

Where some people see 3% as an optimum rate of price inflation, after adjusting downward for productivity advances, effectively decimating the unit exchange value of money over a typical lifetime, I see insanity.

Regards, Don

[Tom Hanna]

Will a 25-basis point spread between the discount and federal funds rates with the Fed practically begging any financial institution with a pulse (even a faint one) to borrow at the discount window change Cowen's analysis?

[Grodge]

Your primer on the gold standard is excellent.

The sentiment for the gold standard has gained popularity recently due to the public's perception of the cravennous of the political establishment.

Nutjobs like Ron Paul will always be a small minority, but their message resonates in times like these.

When real world price inflation is seemingly ignored and the Fed continues to raise interest rates to bolster the investment community who apparently made horrific decisions based on greed, Joe Sixpack starts to get antsy.

Can you blame the average homeowner who pays their bills and gets a paycheck valued in US dollars and now watches as the government devalues those assets, and chooses not to regulate the financial markets? No moral hazard? It seems that the regulatory and enforcement agencies that give our fiat currency its value have been asleep at the switch.

The fact is that most of us non-economists have little understanding of the workings of money (your website has edumacated me intensely), but the frustration is definitely mounting.

The gold standard will never come back, but the growing popularity of the argument in its favor today is a reflection of the extreme lack of trust in our government to be accurate and truthful in valuing our money.

Your ranting and railing against Ron Paul somewhat misses that point.