Posted by: Dirk | July 30, 2009

(Book review) A Tract on Monetary Reform

John Maynard Keynes in his book from 1923 lays out the need for a stable currency. There are two types of stability: internal stability and external stability. Both are important. Internal stability must ensure that the value of money is stable as to guarantee that contracts in money terms keep their expected values. Also, production is affected by monetary instability, especially by deflation. External stability is important mainly for foreign trade. Keynes discusses whether it makes sense at this point after WW I to return to the gold standard (no) and whether one should prefer internal price stability to external price stability (yes). He concludes that

perhaps the British Empire (apart from Canada) and the countries of Europe would adopt the sterling standard; whilst Canada and the other countries of North and South America would adopt the dollar standard. But each could choose freely, until, with the progress of knowledge and understanding, so perfect a harmony had been established between the two that the choice was a matter of indifference.

In chapter V we can see what was lost from Keynes (p. 177):

Chapter V


A SOUND constructive scheme must provide – if it is to satisfy the arguments and the analysis of this book:

I. A method for regulating the supply of currency and credit with a view to maintaining, so far as possible, the stability of the internal price level; and

II. A method for regulating the supply of foreign exchange so as to avoid purely temporary fluctuations, caused by seasonal or other influences and not due to a lasting disturbance in the relation between the internal and external price level.

As of today, central banks regulate the supply of money in order to change interest rates, but they have neglected the supply of credit. That seems to be the main problem with the inflation-targeting approach in that is blind with respect to financial markets and the bubbles created there.

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