I recently read of George Selgin concluding that a commodity based target for the FED would be a bad idea. It seemed like he would be writing about it so I waited a bit to ask him and to my delight he pointed me to a new article on the subject: More on Commodity Price Targeting
The topic is especially interesting to me not only because the concept is part of John Nash’s proposal Ideal Money but also because it was a (mistaken) point of contention Selgin had with Nash’s work:
In the article George notes something very parallel to Nash’s work:
The narrower the commodity set, the greater this problem becomes. For that reason a gold price target would generally be even less reliable than a broader commodity price target
The above is the basis for the reasoning for the conceptual device Nash uses to frame his proposal which he calls an ICPI (an industrial consumption price index)-an array of commodity prices:
The ultimately launched concept of “Ideal Money” became possible when I conceived of a practical basis for a standardization of the comparison of the value of the currency with an appropriate standard or ideal. And the key to that was the idea of an ICPI or (international) “Industrial Consumption Price Index”. (That is thus like the U.S. CPI which controls Social Security payouts but is adapted to relate to industrial producers rather than to individuals and it is envisioned as being essentially dependent, by choice of its definition, on costs that are very global in nature, like, for example, the cost of oil from OPEC and other producers or the cost of platinum, tungsten, or nickel.)
Selgin goes on to show the complexity involved in using commodities as a FED target:
The channels through which monetary policy affects commodity prices are complex and circuitous,” Garner says. Consequently, “it would be difficult for policymakers to produce the desired movements in an index of sensitive commodity prices.
This is similar to a passage by Nash which explains why his ICPI concept is actually fatal in implementation:
We can see that times could change, especially if a “miracle energy source” were found, and thus if a good ICPI is constructed, it should not be expected to be valid as initially defined for all eternity. It would instead be appropriate for it to be regularly readjusted depending on how the patterns of international trade would actually evolve.
Here, evidently, politicians in control of the authority behind standards could corrupt the continuity of a good standard…
Selgin also notes there is a limitation in a commodity price standard because of, for example, supply side technological based shocks:
I wouldn’t count on a positive finding, for commodity prices are especially likely to be influenced by supply-side innovations (such as gold discoveries) or blights
This is comparable to what Nash explained about the limitation of a gold standard:
Nowadays, however, few would propose a return to the actual use of simply the metal gold as a standard, for the following reasons.(i) The cost of mining gold effectively does depend on the technology. Recent cyanide leaching techniques have made it possible again to profitability mind gold at formerly abandoned sites in the U.S. so that it is now a big producer. However, the unpredictability of the cost is a negative factor.
George does add a caveat to his stance of being against a commodity standard-a (reasonable) monetary rule of thumb for the FED is something he supports over the current policy of having a moving target:
I hasten to add that I’m far from being opposed to any sort of monetary rule. On the contrary: I’d much prefer a Fed that stuck to a predictable, systematic policy, to our present Fed with its constant policy flipping and flopping.
This seems to be what Nash was getting at with his concept of the ICPI and with this statement:
My position is that the appropriate“target rate” for measured inflation is zero.
The Re-solution
So a monetary rule would be better in George’s opinion but a commodity standard is not such a good idea. Gold is not ideal because it could have supply shocks and it’s difficult to tell the effects such a standard would have on (for example) gold in this position. George admits an array of commodities would be better but suggests that having a committee try to optimize this array would be futile because of the complexity.
So let us imagine the Selginian rule of thumb whatever he feels it should be and call it: Selgins Fed rule.
Then let us imagine all central banks in the world adopt SFR and this rule is better than today’s “constant policy flipping and flopping”.
Then I would want to ask Selgin what would the international exchange rates of the centrally banked currencies look like if they all adhered to the SFR in a trustworthy manner?
And perhaps we need to add to the question the assumption that there is an apolitically issued high value settlement medium that functions as a clearing mechanism for nations (ie really good arbitrage).
Then what would be the internationally viewed rating for each currency be?
And here we arrive with Selgin’s reasoning to Nash’s conclusion, made possible by exploring the concept of the ICPI but never actually using it as a basis for his argument:
It seems possible and not unlikely, however, that if two states evolve towards having currencies of more stable value as measured locally by national CPI indices that then also these distinct currencies would tend to evolve towards more stable comparative relations of value.
Then the limiting or “asymptotic” result of such an evolutionary trend would be in effect “ideal money” but this as a result achieved without the adoption of anything like an ICPI index as a basis for the standard of value.
