Monday, May 25, 2015

John Nash and Ideal Money

I was not aware of this proposal from John Nash:
Nash’s lecture, “Ideal Money and Asymptotically Ideal Money,” centered on the connection between fluctuation in inflation and exchange rates and the perceived long-term value of money. “Good money,” he argued, is money that is expected to maintain its value over time. “Bad money” is expected to lose value over time, as under conditions of inflation … Nash argued that the emphasis on stabilizing the value of currency should extend to the international level, where exchange rates represent currencies’ value relative to each other. He proposed that international exchange rates be fixed by pegging the value of each currency to a standardized basket of commodities, called the “industrial consumption price index.” Such a policy would curtail the ability of central banks to make monetary policy…After World War II, international exchange rates were fixed, with currencies’ value first pegged to gold and later fixed at set ratios. That regime was abandoned in the early 1970s, when increasing inflation forced the United States to devalue the dollar. Nash said his system would be more stable and sustainable than the gold standard because exchange rates would not be seriously affected by fluctuations in any one commodity….Nash responded with caution to the suggestion from an audience member that a system of currencies approaching perfect stability would ultimately produce a system with only one world currency. “There’s nothing wrong with it,” Nash said. But he added, “In practice, I’m a little distrustful of the politicians at the level of the United Nations and elsewhere,” who would be in charge of administering a world currency.
Nash’s lecture was in 2005. While the U.S. did endure the Great Inflation but from 1983 to 2007, we enjoyed the Great Moderation without pegging the dollar to any basket of commodities. But let’s also consider the case of Italy and the EU experiment with a common currency. Over the 26 year period where the Italian lire was free to devalue, Italy’ consumer price index rose by more than a factor of 11, which translates into an average inflation rate of 9.7 percent per year. Since 1999, Italy’s average inflation rate has been only 2 percent. In 2005, things seems to be working well. Of course, we know that the EU experiment has been a disaster during the Great Recession as noted by Barry Eichengreen and Peter Temin:
We describe in this essay why the gold standard and the euro are extreme forms of fixed exchange rates, and how these policies had their most potent effects in the worst peaceful economic periods in modern times. While we are lucky to have avoided another catastrophe like the Great Depression in 2008-9, mainly by virtue of policy makers' aggressive use of monetary and fiscal stimuli, the world economy still is experiencing many difficulties. As in the Great Depression, this second round of problems stems from the prevalence of fixed exchange rates. Fixed exchange rates facilitate business and communication in good times but intensify problems when times are bad.
This reminds me of The Rule of the Games by Ronald McKinnon in 1996:
The Rules of the Game brings together essays, written over the course of thirty years, by a major figure in the field that analyze and compare a wide variety of important international monetary regimes. These range from the establishment of the gold standard in the nineteenth century through Bretton Woods, the dollar standard, floating exchange rates, the European Monetary System, to current proposals for reforming world monetary arrangements.
Nash contributed immensely to game theory but I’m not sure he revisited the issue of international monetary regimes in light of the Great Recession.


Ramanan said...

FYI: Lecture link here

Bruce Wilder said...

“Good money,” he argued, is money that is expected to maintain its value over time. “Bad money” is expected to lose value over time, as under conditions of inflation …
Did he actually argue that? Because it isn't clear to me that he did. He does allow that money might be in the nature of a public utility, like a municipal water supply. But, what he seems to advocate for is money without management by Treasuries and Central Banks. Would we want a municipal water supply without engineers to monitor and regulate purity and pressure?
It is a pretty easy proposition to show that a practically useful money should exhibit a positive rate of inflation. In Nash's terms, this would be "Bad Money" driving out a putative "Good Money", but that is actually what one wants to have happen. We want an inflationary "Bad Money" to drive savings into investment.
I'd worry more about Bad Economists driving out Good Economics.

ProGrowthLiberal said...

Thanks for the original speech. In a note Nash notes:

The talk text, just for the “ideal money” topic, originally derives from my outline for the
lectures given at various specific locations of the “European School of Economics” in Italy
during October 1997. Subsequent to that time, after consulting with some of the economics
faculty at Princeton, I learned of the work and publications of Friedrich von Hayek. I must
say that my thinking is apparently quite parallel to his thinking in relation to money and
particularly with regard to the non-typical viewpoint in relation to the functions of the
authorities which in recent times have been the sources of currencies (earlier “coinage”).) said...

Austrians like this proposal of Nash's, seeing it as closely related to those of Hayek as well as Leland Yeager, both of whom proposed commodity index standards of value for money.