Wouldn't a gold standard have a deflationary, and thus, pro-unemployment, bias and wouldn't it inhibit the Federal Reserve Board's ability to provide liquidity and credit when needed, as when leading indicators (such as unemployment, industrial production, and consumer confidence) are down?

A genuine gold standard (as opposed to one manipulated or otherwise compromised by government), if historical experience is any guide, would likely produce mildly fluctuating price levels but over time, stable to generally declining prices. I understand that some people who have what I regard as an unfounded bias toward rising prices would see this as a negative thing but steady to falling prices is one way the free market brings more and better goods within the reach of more people, thereby raising their standard of living. You see that most vividly today, of course, with high-tech items like computers; they are better than ever and a fraction of their earlier costs.

Unemployment is not a function of the price level. It is a function of real wages and unit productivity. If prices are generally falling, wages need not fall if productivity is rising. Wages remaining the same amid falling prices means real wages are improving. Unemployment occurs when the real wage exceeds productivity, which union pressure or government mandates or other institutional "stickiness" prevents wages from adjusting to reflect price levels, demand for labor, supply of labor, and productivity. Free the labor market to more quickly respond to changing market conditions, and employment need not be adversely affected at all from stable to declining prices.

Would a gold standard inhibit the Federal Reserve's ability to inject liquidity? Yes, indeed it does. In fact, a genuine gold standard and a central bank that manipulates interest rates and creates money and credit at whim are essentially incompatible. Moreover, I would argue that crises in the economy that seem to necessitate the kind of Federal Reserve action you refer to are almost invariably due to foolish interventionist policies of the Fed or the government that created it.

See my essay, "Great Myths of the Great Depression" for more information on how this applies to the experience of the 1920s and 1930s. In our "Ask the Economist" archives, we also have answers to related questions that will expand on this reply.

"A genuine gold standard and a central bank that manipulates interest rates and creates money and credit at whim are essentially incompatible."

Share More …