Letters to the Editor: The Fed's Monetarism Was Never Anything but Rhetoric
In a column adjacent to your Dec. 4 editorial "The Problem of Monetarism," Vermont Royster refers to the "fable of blind men confronting an elephant." The editorial is a case in point. It considers the symptoms -- fluctuating exchange rates and monetary velocity -- and not the cause -- the unstable monetary policy of the U.S. and some other countries. Insofar as U.S. policy can be said ever to have been monetarist, it was so solely in rhetoric, never in performance. Since the Fed adopted temporarily the rhetoric of monetarism in 1979, monetary growth has been more unstable than in any other postwar period of comparable length. That hardly constitutes a monetarist policy, and it has had the anticipated results: similar instability in interest rates, the economy, and exchange rates.</br></br>An instructive example is the contrast in Japan between policy and results pre-1973 and post-1973: erratic and unstable monetary growth pre-1973 culminating in monetary growth and inflation both reaching around 25% a year; highly stable and gradually declining monetary growth post-1973 along with stability in the economy and a steady reduction of inflation. The Bank of Japan has been the least monetarist central bank in its rhetoric, the most monetarist in its policy. It has also achieved the best results.</br></br>The break in the trend of velocity, from steadily rising up to 1981 to roughly horizontal thereafter, is no mystery. So long as inflation was accelerating there was a growing incentive for holders of cash to economize on their balances; disinflation beginning in 1980 altered sharply the incentives and increased desired cash balances relative to income. The same phenomenon has been observed whenever and wherever accelerating inflation has been succeeded by disinflation.</br></br>The editorial writer may not believe it "especially helpful to control nominal GNP," but that is the most monetary policy can do. The monetary authorities ultimately control only a nominal magnitude, the monetary base. Changes in that nominal magnitude do affect real magnitudes in the short run; however, their lasting effect is predominantly on nominal magnitudes -- which is why limiting monetary growth is essential to avoid inflation.</br></br>Finally, the editorial asserts that "the world is moving toward international monetary reform, abandoning the experiment with floating exchange rates." Another example of the blind man feeling the elephant. There is indeed "a remarkable degree of consensus" that it would be nice to have a better system. When is there not? The point is that everybody has a different system in mind and there is no consensus whatsoever on a specific alternative to the present system. The editorial is making the same mistake as was made some years ago by believers in the existence of a consensus on restoring a gold standard. In the course of the Commission's hearings, the appearance of consensus rapidly dissolved as it became clear that the consensus was solely on a rhetorical symbol and did not exist with respect to any specific variant of a gold standard.