Wednesday, January 21, 2015

Gold was irrelevant

Krugman writes this in the course of a post about the Swiss National Bank exchange rate peg:
The trouble is that regime change is hard to engineer. FDR did it by taking America off the gold standard, but going off gold isn’t something you get to do very often.
Was the switch away from the gold standard really the monetary regime change that got us out of the liquidity trap conditions of the Great Depression?

FDR takes the US off the gold standard in 1933 [corrected, H/T srin]. Bretton-Woods (1944-1945) comes a couple years after the onset of the Federal Reserve pegging (via an agreement with the Treasury in 1942) short term interest rates at 0.375% (3/8) and 'implicitly' capping long term rates at 2.5%. This policy regime lasts until the Treasury-Federal Reserve Accord in 1951. The last vestige of gold convertibility falls away in 1971. Those events basically describe the potential moments of monetary policy regime change we have available.

You can see the effect of the interest rate peg in the short term interest rate data:

If we look at the three solutions to the information transfer model equations that are required to cover the US price level from the 1920s to the present day, our current solution (blue) doesn't take over until the late 1950s. FDR takes the US off the gold standard in the 1930s, however, the liquidity trap solution (red) continues to be in effect until after 1940. The hyperinflation solution (purple) is in effect from the early 1940s to the 1950s.

If we compare this to the list of historical events, the monetary policy regime change appears to have coincided with the lack of independence of the Federal Reserve in the 1940s ... and is not related to gold at all.

The big events in the gold standard, 1933 [corrected, H/T srin] (FDR leaves gold), 1944 (Bretton-Woods) and 1971 (terminating gold convertibility) all happen in the middle of these solution branches.

This analysis lends itself to the policy conclusion that the BoJ, SNB, ECB and Fed (and anyone else) should abandon central bank independence and adopt an interest rate peg (for long and short rates) to escape the current liquidity trap.


  1. Jason,

    Small quibble. FDR did not take office until 1933 and took the US off the gold standard in April 1933.

    1. You are right. Not sure why I wrote that. I will make the edit.

  2. I always thought that too much was made of getting off the gold standard in 1933. Many indicators actually bottomed in 1932 and were turning up before FDR took office in April 1933, including inventory investment. Granted, wholesales prices started rising only after FDR took office.

    I also think that although the US was off the gold standard, the Fed, the federal government, markets, and businesses generally behaved as if the implicit gold standard constraints on monetary base expansion held--until the onset of WWII.

    1. I had seen graphs like this one and thought there might be something to it:

      But both the US and the UK (at least) pegged their interest rates around the same time as each other and Japan drops the standard and comes back. I'd like to see the stories behind the other currencies ... maybe abandoning gold is a monetary regime change for some countries, but it's hardly a universal story.


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