Abstract
This paper explores James Buchanan’s contributions to monetary economics and argues these contributions form the foundation of a robust monetary economics paradigm. While often not recognized for his contributions to monetary economics, Buchanan’s scholarship offers important insights for current debates, especially the renewed interest in narrow banking in the wake of the financial crisis. We argue that the post-2007 crisis milieu creates a unique opportunity to recognize, as Buchanan did, the vital role that money plays in the market as the ‘grammar of commerce.’ That recognition makes the need for more fundamental reform of our monetary regimes at the constitutional level more apparent, making Buchanan’s work on monetary constitutions more relevant than ever before. We then discuss how adopting Buchanan’s monetary framework can improve both monetary scholarship and institutions.
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Notes
In this paper, we use the word ‘constitution’ as Buchanan used it, to mean ‘rules for rule-making.’ Buchanan’s Nobel lecture (Buchanan 1987) provides an overview of a constitutional perspective on economic policy.
We focus exclusively on the monetary explanations for the financial crisis in this paper. Other actions undertaken by the Fed, including in its role as lender of last resort or as financial regulator, may also have contributed to the financial crisis (e.g., Cochrane 2010; Hogan et al. 2015; Morrison 2011; more generally, see Stern and Feldman 2004 for an argument about earlier institutionalization).
Each of the essays in Yeager’s edited volume originally were lectures given by the authors at the Thomas Jefferson center in 1960.
Buchanan ultimately contends that the “policy decision as between a managed monetary system and an automatic system should be made only after a careful analysis of the relative costs and benefits expected from the operation of each system” (Ibid, pp. 165–166), showing he is not opposed to managed systems a priori. However, since in his essay he declines to discuss the operations of a managed system in favor of an automatic system, we can discern where Buchanan views scarce intellectual resources are more fruitfully deployed, at least at the margin. This predilection will grow into a conviction over the course of his life’s writings on the subject, as we will show in subsequent sections.
Elsewhere, Buchanan (2010b) argues that this view is an essential difference between old and new Chicago. If the overemphasis on formalism and lack of appreciation of the importance of rules is partly to blame for the financial crisis, then the economics profession should look to old Chicago for guidance.
Of course, Buchanan’s emphasis on “predictability” is present, as it was in his early work, but many possible monetary constitutions may satisfy that arrangement.
We will detail this argument in Sect. 4.3: on the ineffectiveness of non-constitutional constraints.
The great moderation, if caused by improved central bank performance, could provide compelling evidence that informal monetary rules can effectively constrain monetary authorities. While proponents of this view certainly have been heard from (e.g., Bernanke 2004), the evidence is mixed at best (Hogan 2015; Hogan and Smith 2017). For instance, the great moderation equally could have been caused by good fortune, financial innovation, or structural improvements to the economy (Carlino 2007; Jenson et al. 2017; Stock and Watson 2003; Summers 2005). In addition, while GDP growth has been less volatile growth during the great moderation period, large economic crashes also have been more frequent (Jorda et al. 2017; Jenson et al. 2017).
Other scholars working in the classical liberal tradition, such as F. A. Hayek and Milton Friedman, did see their ideas on monetary policy gradually evolve towards the adoption of Buchanan’s concerns, but ultimately even their intellectual evolutions did not have a discernable influence on the direction of monetary scholarship (Smith and Boettke 2015).
Dissenting views exist, however. Prominent examples include Barro (1978, 1979), Barro and Rush (1977), Dwyer (1985), Faust and Irons (1999) and King and Plosser (1985). See Blinder (1980), Gordon (1980), Small (1979), Weintraub (1978) and Allen and Smith (1983) for a critique of Barro on this point.
Mankiw (2001) argues that, at least in the 1990s, the United States was following an informal policy of inflation targeting.
Regarding the efficacy of inflation targeting, Ball and Sheridan (2005, p. 250) find that “On average there is no evidence that inflation targeting improves performance as measured by the behavior of inflation, output, or interest rates.” Part of the reason for this is the failure of inflation targeting countries to actually achieve their targets; Roger and Stone (2005) find that inflation-targeting countries miss their targets about 30% of the time. These findings imply that Buchanan’s arguments have not been overcome, but ignored. Without an official rule explicitly enshrouded in a constitution with penalties for non-compliance, inflation targeting has proven too malleable a policy to restrain monetary authorities (Salter 2014a; Lohmann 2000). In addition, Beckworth (2014) makes the case that inflation-targeting is destabilizing because it doesn’t deal well with supply and demand shocks.
This is a very brief overview that simplifies many of the relevant issues, such as that posed by in-concert overexpansion. But free banking systems are robust to that problem as well. We encourage the reader to consult the sources previously cited to get a fuller picture. Selgin (1988) is particularly useful in terms of theory, and White (1984) in terms of practice.
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Boettke, P.J., Salter, A.W. & Smith, D.J. Money as meta-rule: Buchanan’s constitutional economics as a foundation for monetary stability. Public Choice 176, 529–555 (2018). https://doi.org/10.1007/s11127-018-0580-y
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DOI: https://doi.org/10.1007/s11127-018-0580-y
Keywords
- Central banking
- James M. Buchanan
- Monetary constitution
- Monetary stability
- Federal reserve
- Rules versus discretion