Money and the rule of law

Abstract

Contemporary monetary systems permit those in positions of authority to exercise discretionary power in the pursuit of monetary policy objectives. We argue there are strong prima facie reasons why this is normatively problematic. Engaging the literature on the rule of law, we argue that a general and nondiscriminatory rule ought to apply to monetary institutions for the same reasons such a rule ought to apply to other important institutions. We recognize that this prima facie case may be overcome by sufficiently strong consequentialist concerns, but show that these concerns are ungrounded: discretionary monetary authorities, both in theory and practice, perform poorly. We thus affirm the importance of the rule of law for monetary policy as a requisite for both non-arbitrary governance and macroeconomic stability.

This is a preview of subscription content, log in to check access.

Notes

  1. 1.

    Central bankers make up for this lack of knowledge through the use of macroeconomic models calibrated with various macroeconomic statistics. Whether this substitute is ‘good enough for government work,’ i.e. works passably well, we consider in a subsequent sub-section. See also Salter and Smith (2016).

  2. 2.

    By ‘capture’ we mean ‘come to serve the ends of parties whose interests differ from those related to the institution’s stated purpose.’

  3. 3.

    Mankiw advises further skepticism concerning the extent to which the rules vs. discretion debate has had any practical effects on central banking. “[T]he institutional changes we have observed are at best loosely connected to the issues raised in the theoretical literature” (Mankiw 2006, p. 16).

  4. 4.

    Taylor (2012a, pp. 1024–1030) also provides evidence that this was partially causally attributable to monetary factors.

References

  1. Aguiar-Hicks, R., Hogan, T., and Smith, D. J. (2014). Central Banking Without Romance. Available at SSRN: https://ssrn.com/abstract = 2536431.

  2. Barro, R. J., & Gordon, D. B. (1983). Rules, discretion and reputation in a model of monetary policy. Journal of Monetary Economics, 12(1), 101–121.

    Article  Google Scholar 

  3. Bédard, M. (2014). Robust Political Economy and the Insolvency Resolution of Large Financial Institutions. Available at SSRN: http://www.ssrn.com/abstract = 2494684.

  4. Boettke, P. J., & Candela, R. (2014). Hayek, Leoni, and law as the fifth factor of production. Atlantic Economic Journal, 42(2), 123–131.

    Article  Google Scholar 

  5. Boettke, P. J., Coyne, C. J., Leeson, P. T., & Sautet, F. (2005). The new comparative political economy. The Review of Austrian Economics, 18(304), 281.

    Article  Google Scholar 

  6. Boettke, P. J., and Smith, D. J. (2015a). Monetary Policy and the Quest for Robust Political Economy. Available at SSRN: https://ssrn.com/abstract = 1764267.

  7. Boettke, P. J., & Smith, D. J. (2013). Federal Reserve Independence: A Centennial Review. Journal of Prices and Markets, 1(1), 31–48.

    Google Scholar 

  8. Boettke, P. J., & Smith, D. J. (2015b). An episodic history of Federal Reserve Independence. The Independent Review, 20(1), 99–120.

    Google Scholar 

  9. Borio, C., and Disyatat, P. (2011). Global Imbalances and the Financial Crisis: Link or no Link? Available at BIS: http://www.bis.org/publ/work346.pdf. Bank for International Settlements.

  10. Brennan, G., & Buchanan, J. M. (2000). The reason of rules: constitutional political economy. Indianapolis: Liberty Fund.

  11. Buchanan, J. M. (1962). Predictibility: the criterion of monetary constitutions. In L. B. Yeager (Ed.), In search of a monetary constitution (pp. 155–183). Cambridge: Harvard University Press.

    Google Scholar 

  12. Buchanan, J. M. (1999). The ethics of constitutional order. In The collected works of James M. Buchanan volume 1: the logical foundations of constitutional liberty (p. 368). Indianapolis: Liberty Fund, Inc.

    Google Scholar 

  13. Buchanan, J. M. (2001). Economics: between predictive science and moral philosophy. In Collected works of James M. Buchanan (Vol. 17, p. 501). Indianapolis: Liberty Fund, Inc.

    Google Scholar 

  14. Buchanan, J. M. (2010). The Constitutionalization of money. Cato Journal, 30(2), 251–258.

    Google Scholar 

  15. Buchanan, J. M., & Congleton, R. D. (2003). Politics by principle, not interest: toward nondiscriminatory democracy. The collected works of James M. Buchanan, volume 11. Indianapolis: Liberty Fund.

    Google Scholar 

  16. Cachanosky, N., & Salter, A. W. (2016). The view from Vienna: an analysis of the renewed interest in the Mises-Hayek theory of the business cycle. Review of Austrian Economics, forthcoming. doi:10.1007/s11138-016-0340-5.

    Google Scholar 

  17. Calvo, G. (2013). Puzzling over the Anatomy of Crises: Liquidity and the Veil of Finance. IMES Discussion Paper Series. Available at: https://ideas.repec.org/p/ime/imedps/13-e-09.html. Institute for Monetary and Economic Studies, Bank of Japan.

  18. Cargill, T. F., & O’Driscoll, F. P. J. (2013). Federal Reserve Independence: reality or myth. Cato Journal, 33(3), 417–435.

    Google Scholar 

  19. Dixit, A. (1991). Irreversible investment with price ceilings. Journal of Political Economy, 99(3), 541–557.

    Article  Google Scholar 

  20. Dixit, A. (1995). Irreversible investment with uncertainty and scale economies. Journal of Economic Dynamics and Control, 19(1–2), 327–350.

    Article  Google Scholar 

  21. Dixit, A., & Pindyck, R. S. (1994). Investment under uncertainty. Princeton: Princeton University Press.

    Google Scholar 

  22. Ferguson, A. (1782). An essay on the history of civil society (5th ed.). London: T. Cadell.

    Google Scholar 

  23. Fishe, R. P. H. (1991). The Federal Reserve Amendments of 1917: the beginning of a seasonal note issue policy. Journal of Money, Credit and Banking, 23(3), 308.

    Article  Google Scholar 

  24. Frankel, S. H. (1977). The Federal Reserve Amendments of 1917: the beginning of a seasonal note issue policy. New York: St. Martin’s Press.

    Google Scholar 

  25. Hamburger, P. (2014). Is administrative law unlawful? Chicago: University of Chicago Press.

    Google Scholar 

  26. Hayek, F. A. (1945). The use of knowledge in society. American Economic Review, 35(4), 519–530.

    Google Scholar 

  27. Hayek, F. A. (1948). Individualism and economic order. Chicago and London: University of Chicago Press.

    Google Scholar 

  28. Hayek, F. A. (1990). Denationalization of money-the argument refined: an analysis of the theory and practice of concurrent currencies (third). London: The Institute of Economic Affairs.

    Google Scholar 

  29. Hayek, F. A. (2011). The constitution of liberty: the definitive edition. In R. Hamowy (Ed.), The collected works of F.A. Hayek: 17. Chicago: University of Chicago Press.

    Google Scholar 

  30. Hendrickson, J. R., and Salter, A. W. (2015). The Constitution of a Financial System. Available at SSRN: https://ssrn.com/abstract = 2682624.

  31. Hetzel, R. (2012). The great recession: market failure or policy failure? Cambridge: Cambridge University Press.

    Google Scholar 

  32. Hogan, T. L. (2015). Has the fed improved U.S. economic performance? Journal of Macroeconomics, 43, 257–266.

    Article  Google Scholar 

  33. Kerekes, C. B., & Williamson, C. R. (2012). Discovering law. Griffith Law Review, 21(2), 432–447.

    Article  Google Scholar 

  34. Kirzner, I. M. (1998). Coordination as a criterion for economic “goodness.”. Constitutional Political Economy, 9(4), 289–301.

    Article  Google Scholar 

  35. Kirzner, I. M. (2015). Competition and entrepreneurship. Chicago: University of Chicago Press.

    Google Scholar 

  36. Koppl, R. (2002). Big players and the economic theory of expectations. London: Routledge.

    Google Scholar 

  37. Koppl, R. (2014). From Crisis to Confidence: Macroeconomics after the Crash. In Institute of Economic Affairs Monographs, Hobart Paper No. 175.

  38. Kydland, F., & Prescott, E. (1977). Rules rather than discretion: the inconsistency of optimal plans. The Journal of Political Economy, 85(3), 473–492.

    Article  Google Scholar 

  39. Lavoie, D. (2015). Rivalry and central planning. Arlington Virginia: Mercatus Center at George Mason University.

    Google Scholar 

  40. Leeson, P. T., & Subrick, J. R. (2006). Robust political economy. The Review of Austrian Economics, 19(2–3), 107–111.

    Article  Google Scholar 

  41. Leijonhufvud, A. (2009). Out of the corridor: Keynes and the crisis. Cambridge Journal of Economics, 33(4), 741–757.

    Article  Google Scholar 

  42. Leoni, B. (1961). Freedom and the law (expanded third edition). Indianapolis: Liberty Fund.

    Google Scholar 

  43. Lomasky, L. (1990). Rights, persons, and the moral community. Oxford: Oxford University Press.

    Google Scholar 

  44. Mankiw, G. (2006). The macroeconomist as scientist and engineer. Journal of Economic Perspectives, 20(4), 29–46.

    Article  Google Scholar 

  45. Mankiw, G. (2007). Jon Stewart is a Genius. Accessed 1 January 2017. Available at: http://gregmankiw.blogspot.com/2007/09/excellent-question.html.

  46. Mehrling, P. (2011). The new Lombard street: how the fed became the dealer of last resort. Princeton: Princeton University Press.

    Google Scholar 

  47. Meltzer, A. H. (2011). Politics and the fed. Journal of Monetary Economics, 58(1), 39–48.

    Article  Google Scholar 

  48. Mises, L. v. (1935). Economic calculation in the socialist commonwealth. In F. A. Hayek (Ed.), Collectivist economic planning: critical studies on the possibilities of socialism (p. 87). London: Routledge and Kegan Paul LTD..

    Google Scholar 

  49. Mises, L. v. (2007). Bureaucracy. Indianapolis: Liberty Fund.

    Google Scholar 

  50. Nikolsko-Rzhevskyy, A., Papell, D. H., & Prodan, R. (2014). Deviations from rules-based policy and their effects. Journal of Economic Dynamics and Control, 49, 4–17.

    Article  Google Scholar 

  51. Niskanen, W. A. Jr. ([1971] 2007). Bureaucracy and representative government. Aldine Transaction: Piscataway.

  52. Paniagua, P. (2016). The robust political economy of central banking and free banking. The Review of Austrian Economics, 29(1), 15–32.

    Article  Google Scholar 

  53. Pennington, M. (2011). Robust political economy: classical liberalism and the future of public policy. Cheltenham: Edward Elgar Publishing Limited.

    Google Scholar 

  54. Salter, A. W. (2014). Is there a self-enforcing monetary constitution? Constitutional Political Economy, 25(3), 280–300.

    Article  Google Scholar 

  55. Salter, A. W., and Smith, D. J. (2016). What You Don’t Know Can Hurt You: Knowledge Problems in Monetary Policy. Available at SSRN: https://ssrn.com/abstract = 2741289.

  56. Salter, A. W., and Tarko, V. (2015). Polycentric Banking and Macroeconomic Stability. Available at SSRN: https://ssrn.com/abstract = 2686368.

  57. Selgin, G. (1988). The theory of free banking: money supply under Competetive note issue. Lanham: Rowman and Littlefield.

    Google Scholar 

  58. Selgin, G., Lastrapes, W. D., & White, L. H. (2012). Has the fed been a failure? Journal of Macroeconomics, 34(3), 569–596.

    Article  Google Scholar 

  59. Simmel, G. (2011). The Philosophy of Money. (D. Frisby, Ed.) (Routledge). New Haven: Routledge.

  60. Steil, B., & Hinds, M. (2009). Money, markets, and sovereignty. New Haven: Yale University Press.

    Google Scholar 

  61. Stringham, E. P., & Zywicki, T. J. (2011). Hayekian anarchism. Journal of Economic Behavior and Organization, 78(3), 290–301.

    Article  Google Scholar 

  62. Sumner, S. (2011). Re-Targeting the Fed. National Affairs, 9. Available at: http://www.nationalaffairs.com/publications/detail/re-targeting-the-fed. In National Affairs

  63. Sumner, S. (2012). How nominal GDP targeting could have prevented the crash of 2008. In D. Beckworth (Ed.), Boom and bust banking: the causes and cures of the great recession (pp. 129–164). Oakland: Independent Institute.

    Google Scholar 

  64. Sumner, S. (2015). Nominal GDP futures targeting. Journal of Financial Stability, 17, 65–15.

    Article  Google Scholar 

  65. Taylor, J. B. (2007). Housing and Monetary Policy. Available at SSRN: https://ssrn.com/abstract=1077808. Cambridge, MA.

  66. Taylor, J. B. (2009). Getting off track: how government actions and interventions caused, prolonged, and worsened the financial crisis. Stanford: Hoover Institution Press.

    Google Scholar 

  67. Taylor, J. B. (2012a). Monetary policy rules work and discretion Doesn’t: a tale of two eras. Journal of Money, Credit and Banking, 44(6), 1017–1032.

    Article  Google Scholar 

  68. Taylor, J. B. (2012b). The Dangers of an Interventionist Fed. Available at: http://www.wsj.com/articles/sb10001424052702303816504577307403971824094. The Wall Street Journal.

  69. Tullock, G. (2005). In C. K. Rowley (Ed.), Bureaucracy. Indianapolis: Liberty Fund.

    Google Scholar 

  70. Wagner, R. E. (2010). Mind, society, and human action: time and knowledge in a theory of social economy. New York: Routledge.

    Google Scholar 

  71. White, L. H. (1984). Competitive payments systems and the unit of account. The American Economic Review, 47(4), 699–712.

    Google Scholar 

  72. White, L. H. (2005). Investigating the apparatus. Econ Journal Watch, 2(2), 325–354.

    Google Scholar 

  73. White, L. H. (2010). The rule of law or the rule of central bankers? Cato Journal, 30(3), 451–463.

    Google Scholar 

  74. White, L. H., Vanberg, V. J., and Köhler, E. A. (2015). Renewing the Search for a Monetary Constitution. Washington D.C.: Cato Institute.

  75. Yeager, L. B. (1962). In L. B. Yeager (Ed.), In search for a monetary constitution. Cambridge: Harvard University Press.

    Google Scholar 

  76. Zelmanovitz, L. (2015). The ontology and function of money: the philosophical fundamentals of monetary institutions. Lanham: Lexington Books.

    Google Scholar 

Download references

Author information

Affiliations

Authors

Corresponding author

Correspondence to Alexander William Salter.

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Furton, G.L., Salter, A.W. Money and the rule of law. Rev Austrian Econ 30, 517–532 (2017). https://doi.org/10.1007/s11138-017-0375-2

Download citation

Keywords

  • Liberalism
  • Monetary institutions
  • Monetary policy
  • Rule of law