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Gold, Fiat Money, and Price Stability

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  • Michael D. Bordo
  • Robert D. Dittmar
  • William T. Gavin

Abstract

Which monetary regime is associated with the most stable price level? A commodity money regime such as the classical gold standard has long been associated with long-run price stability. But critics of the day argued that the regime was associated with too much short-run price variability and argued for reforms that look much like modern versions of price-level targeting. In this paper, we develop a dynamic stochastic general equilibrium model that we use to examine price dynamics under four alternative regimes. They are the gold standard, Irving Fisher's compensated dollar proposal, and two regimes with paper money in which the central bank uses an interest rate rule to run monetary policy. In the first, the central bank uses an interest rate rule to target the price of gold. In the second, there is no convertibility and the central bank targets uses an interest rate rule to target an inflation rate. We find that strict inflation targeting, even though it introduces a unit root into the price level, provides more short-run stability than the gold standard and as much long-term price stability as does the gold standard for horizons shorter than 30 years. We find that Fisher's compensated dollar reduces price level and inflation uncertainty by an order of magnitude at all horizons.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10171.

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Date of creation: Dec 2003
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Publication status: published as Bordo, Michael D., Robert D. Dittmar, and William T. Gavin. "Gold, Fiat Money, and Price Stability." B.E. Journal of Macroeconomics: Topics in Macroeconomics 7, 1 (2007).
Handle: RePEc:nbr:nberwo:10171

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  1. Christopher J. Erceg & Andrew T. Levin, 2001. "Imperfect credibility and inflation persistence," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2001-45, Board of Governors of the Federal Reserve System (U.S.).
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  4. Neely, Christopher J & Roy, Amlan & Whiteman, Charles H, 2001. "Risk Aversion versus Intertemporal Substitution: A Case Study of Identification Failure in the Intertemporal Consumption Capital Asset Pricing Model," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 19(4), pages 395-403, October.
  5. Fujiki, Hiroshi, 2003. "A model of the Federal Reserve Act under the international gold standard system," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(6), pages 1333-1350, September.
  6. Dittmar, Robert D. & Gavin, William T., 2005. "Inflation-targeting, price-path targeting and indeterminacy," Economics Letters, Elsevier, Elsevier, vol. 88(3), pages 336-342, September.
  7. Kevin M. Murphy & Andrei Shleifer & Robert W. Vishny, 1989. "Building Blocks of Market Clearing Business Cycle Models," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 247-302 National Bureau of Economic Research, Inc.
  8. Milton Friedman, 1951. "Commodity-Reserve Currency," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 59, pages 203.
  9. Sargent, Thomas J. & Wallace, Meil, 1983. "A model of commodity money," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(1), pages 163-187.
  10. Bordo, Michael D. & Jonung, Lars, 2000. "A Return to the Convertibility Principle? Monetary And Fiscal Regimes in Historical Perspective," Working Paper Series in Economics and Finance 415, Stockholm School of Economics.
  11. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, Econometric Society, vol. 49(4), pages 1057-72, June.
  12. Allan Meltzer & Saranna Robinson, 1989. "Stability Under the Gold Standard in Practice," NBER Chapters, in: Money, History, and International Finance: Essays in Honor of Anna J. Schwartz, pages 163-202 National Bureau of Economic Research, Inc.
  13. Robert Dittmar & William T. Gavin & Finn E. Kydland, 1999. "Price-level uncertainty and inflation targeting," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Jul, pages 23-34.
  14. King, Robert G & Watson, Mark W, 1998. "The Solution of Singular Linear Difference Systems under Rational Expectations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 1015-26, November.
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Cited by:
  1. Elisa Newby, 2009. " The Suspension of the Gold Standard as Sustainable Monetary Policy," CDMA Conference Paper Series, Centre for Dynamic Macroeconomic Analysis 0907, Centre for Dynamic Macroeconomic Analysis.
  2. Elisa Newby, 2007. "The Suspension of Cash Payments as a Monetary Regime," CDMA Working Paper Series, Centre for Dynamic Macroeconomic Analysis 200707, Centre for Dynamic Macroeconomic Analysis.
  3. Richard C.K. Burdekin & Kris James Mitchener & Marc D. Weidenmier, 2011. "Irving Fisher and Price-Level Targeting in Austria: Was Silver the Answer?," NBER Working Papers 17123, National Bureau of Economic Research, Inc.
  4. Elisa Newby, 2007. "Macroeconomic Implications of Gold Reserve Policy of the Bank of England during the Eighteenth Century," CDMA Working Paper Series, Centre for Dynamic Macroeconomic Analysis 200708, Centre for Dynamic Macroeconomic Analysis.
  5. Shafiee, Shahriar & Topal, Erkan, 2010. "An overview of global gold market and gold price forecasting," Resources Policy, Elsevier, Elsevier, vol. 35(3), pages 178-189, September.
  6. Bordo, Michael D., 2012. "Could the United States have had a better central bank? An historical counterfactual speculation," Journal of Macroeconomics, Elsevier, Elsevier, vol. 34(3), pages 597-607.
  7. A. Malliaris & Mary Malliaris, 2013. "Are oil, gold and the euro inter-related? Time series and neural network analysis," Review of Quantitative Finance and Accounting, Springer, Springer, vol. 40(1), pages 1-14, January.

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