192 Manfred J. M. Neumann Manfred J. M. Neumann is the director of the Institute tor Inter- national Economics and a professor ot economics at the University of Bonn, I Commentary MICHAEL BORDC) PROVIDES US with a WHICH REGIME PERFORMED comprehensive, scholarly study of the history of BEST? the three main international monetary regimes: the gold standard, the dollar standard, and the It is natural to evaluate the welfare implica- floating exchange rate. lie focuses on two tions of monetary regimes by asking what important questions. First, which regime provided different regimes achieve with respect to the the best performance with regard to the levels level and stability of inflation and real growth. of inflation and real growth? Second, what Any monetary regime can be described as a makes an international monetary regime viable? mechanism or device that delivers an average rate of monetary expansion and a variance of Because I am not a historian, I will limit my money growth. With respect to economic per- comments to two areas, I will first discuss the formance, the essential difference is whether a comparative evidence on the performance of particular m-egime pr’ovides governments with the three monetary regimes and use Bordo’s more or less freedom to manipulate the aver- statistics to infer a little more information on age rate of and the variance of monetat-y expan- the role of demand shocks under the different sion. It follows that regime differences should regimes. Thereafter I will concentrate on the be reflected in inflation levels and variances of important issue of determining a monetary inflation and per capita growth. system’s credibility. I find Bordo’s thoughtful Table I draws from Bot-do’s tables I and 4. 1 discussion of the issue useful. I should add, consider the Group of Seven countries as a however, that sometnnes he takes the literatui-e whole, the United States, Germany and Fi-ance too seriously—especially the affirmative litera- and concentrate on the three major periods: the ture on the European Monetary System (EMS). pre-World War I gold standard, the Bret ton \‘evertheless, Bordo forces us to consider which Woods system of the 1950s and 1960s, and the monetary system or standard, if any, can solve floating exchange rate in place since the the credibility problem in terms of firml inid~197Os.’Note that, in contrast to Bordo, 1 do anchoring market expectations about its not separate out the favorable performance of viability. the Bretton Woods convertible subperiod ‘The Group of Seven countries are Canada, France, Germany, Italy, Japan, the United Kingdom and the United States. FEDERAL RESERVE BANK OF ST, LOUIS 193 / fl__ ~ / ~ _/ -I ~r _, /_ ~-~-c — ~:- / ~-~c ~~ ~ ~_-t~ ,___ ~ ~ ~ - w~ ~ v~~Asc/ / ~~ ~ A ~rir4~ ~ ~‘ / ~ ~ ~ / c’~ ~ ‘A ~~\\ N~ ~tr~: —~r~-Jra -~ t~- -- - * ~ - —— -::~~---~~-‘ \t~ ~ - ~~~~/~\_ ~~ ~ rj~t;/~ ~ ~‘t~1~r~tç~ ~t~c~:4;~ ~ / ~ ~ :~~ ~ N ~ ~- V~ ~ S~A*~~ ~ ~ t~a~:c~~~~ p ~ ~s~/ ~ ~‘ \ ~___-c_ , c~~ ~ ~ -,~-- ~ r’-~-~-°~~ 4 ~ ~ ‘~ -7 / /~ -~ ~-\ 4 ~- ~~ ~ \ ~,, ~ / \\~‘~~ ~ ~-/ \-t- a>/ ~ //1-~ ~ ~ — ~ \ ~ ~:~-s-~> - ~ac~~_s~~s~:/~ / /~t~sJ~-~ \ \ t- 4 - ~~~~~ ; -~--~ $-/\ :~- ~tt-’ ~ c~r~ \ç/~ ~ ~ - ~s~iie~ ~: : ~ c:~ ~ - ~ ~H: ~1 t~- c~ ~\/Y\~ a-~ ~ \~C ~- ~~ ~ ‘7 i-.~ 7 7 ~//p tc ,~/ ~ 7~-/’~~’ ~ — -,,~ / ~, f 7 7 - / -, - ‘7 4 ~7’ 7/ :4-- - — - ‘7 -‘7”-? -- - /7- / ‘7 \- ‘7 /-//~/,/ ~ ‘7 ‘7’- “7?“ 4, -~ -~ - - ‘7 - ‘-~ ,,7”’7 -‘ --i’~~~ ‘7~ ~r —~ ~ ~ >-~- ‘ ~-~“ ‘‘-‘77/- (1 959-197(J) in terms of inflation and output. • Third, the Bretton Woods regime exhibited The subperiod looked good on the surface; how- the highest variability of inflation, whereas ever, it was in fact the period when the break- output variability was closer to its level down of Bretton Woods was programmed. More under the float than under the gold generally speaking, for- ant’ i-egime we nught standard. find ey post a good looking suhperiod.2 The first observation on average inflation per- As Bordo and others have pointed out, the formance is well known and understood. It is data permit the following observations: widely accepted that the classical gold standard • First, average inflation was negligible under prevented the manipulation of monetary expan- the gold standard and highest under the sion by enforcing a direct link between the base floating exchange rate. money stock, the national stock of gold and the balance of payments. Though devaluation was • Second, the variabihtv of inflation, as possible by raising the gold parity in national well as that of real growth, was higher currency, it was rare. Thus the gold standard dcliv- under the gold standard than under the wed the lowest average rate of inflation, given that floating exchange i-ate. the available gold stock did not grow much. 2As Anna Schwartz pointed out in the discussion, an evalu- when the EMS came close to collapse, would be seriously ation of the EMS that bypasses the most recent period, misleading. MARCH/APRIL 1993 194 member country of the European snake or EMS. At the other extreme, fiat money cum floating does not put any external constraint on domes- Checking the empirical validity of these con- tic money production. ‘I’hus governments are jectures requires estimating the variance of ft-ce to use money production to collect inflation nominal demand shocks. Bordo’s study pi-ovides tax and to dampen the business cycle. The addi- us with some valuable information in this nonal advantage to governments of the floating respect. Following Blanchard and Quah (19891 exchange rate is that the regime spares them and liavoumi and Eichengr-een (I 99Z) in particu- the political cost of negotiating devaluation. In lar, he has estimated for each country andl each sum, the floating exchange rate is the monetary monetary regime a bivariate vector autoregres- regime most conducive to inflationary policies. sion (VAR) for the rates of change of the price Finally, the I3retton Woods system was in level and output. The lower panel of table I between the gold standat-d and the floating provides the variances of the estimated aggregate exchange rate in that it started as a gold supply and demand shocks? Under the straight- exchange standard but was permitted to forward assumption that the distribution of real degenerate into a pure fiat money standard (the demand shocks was the same over the different dollat- standardl dut-ing the early 1960s when monetary regimes, differences in demand shock the United States gold stock fell short of the variability can he attributed to the operational value of outstanding dollar liabilities. differences of the regimes. More interesting than the average inflation The empirical findings are mixed. The data performance is the observed difference in the reject our I’irst conjecture. For the Group of volatility of inflation and output growth among Seven countries demand shock variability was regimes. But to what extent can this volatility he highest under the gold standard and lowest attributed to the operation of the different under the potentially permissive floating exchange monetary systems? rate regime. The most puzzling aspect is the high demand variability during the gold stand- EXPLORING THE ROLE OF ard period because not only was monetary pol- icy discretion constrained by the rules of the DEMAND SHOCKS regime, but also fiscal discretion was negligible, Apart from determining the level of inflation, at least by today’s standards. monetary regimes differ with respect to nomi- Our second conjecture, in contrast, is con- nal demand shock variability. I propose the firmed. Demand shock vai-iability was lowest in following conjectures. the United States during the Bretton Woods First, nominal demand shock variability is period and in Germany during the float. More- highest under the floating exchange rate and over, it can be shown for Germany using an lowest under the gold standard. This reflects F-test that the demand shock variance of the the diffeiences in the limits to monetary discre- float differed significantly from its value under tion. Because the degree of monetary discretion Bretton Woods at the 1 percent level of sig- is close to zero under the gold standard and nificance. In the United States the level of unlimited under the floating exchange rate, we significance was 10 percent. should observe that the variance of inflation Though we have not seen any test statistics of was caused predominantly by nominal demand Bordo’s VAR estimates, let us assume that the shocks under the floating exchange rate but by estimates are clean. On this assumption we may supply shocks under the gold standard. use them to investigate the contribution of the aggregate demand shocks to the variability of Second, in a fixed-exchange rate system the inflation and output growth under the different system leader sets the floor for nominal demand monetary regimes. To do so requires a model of shock variability. Consequently, for the Bretton aggregate supply and demand to determine the Woods period we should observe that nominal unknown price elasticities of aggregate demand demand shock variability was lowest in the and supply. United States. Similarly, during the floating rate period nominal demand shock variability should Table 2 provides the bare bones of such a have been lower in Germany than in any other model. The model is written in logs and has a 3 See Bordo’s table 4. FEDERAL RESERVE BANK OF ST. LOUIS 195 - - ?~~1-‘7~’7o47//<~~~~C <~~J1~,’ ‘7-?-. ‘-4~’71-~ ~ ‘7s~’74 ~ -~ -~‘--41 , 47/-/’~— ‘7/ ft ~ ~ ~: // “7.‘7”t ‘7’7”-’7t’71~‘~ ‘~ —‘7 —--- — : ,- -. ,, ‘1, ~Gs4’S*M4$P*— titslSo4i/ ‘7 ‘ 4 ‘7 ‘72-2— _ a4,~14~ <‘g’ ~a rn.~~4’ :‘7 “-‘7 t~~’I A4ii~Is$~sS 4fl ‘7’ ~‘~“ ~ ~— ,~r ~“7‘ 4 ~ ‘---,~/-C-’7’ 4/___ ~ - --‘7/--?-, — / / ~7/~~-~ ~/4/~/_ ~ / -/ “7 a’,-, / 4’ 4 — ‘7 / ‘7<’ ‘7< —a - <-‘7--’7 <‘7 ?~ - ,~.