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VII. The Goal of Monetary Policy

VII. The Goal of Monetary Policy

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94 — The Causes of the Economic Crisis

In opposing a single precious metal standard, monetary policy
exhausted itself in the fruitless attempt to make bimetallism an
actuality. The results which must follow the establishment of a
legal exchange ratio between the two precious metals, gold and
silver, have long been known, even before Classical economics
developed an understanding of the regularity of market phenomena. Again and again Gresham’s Law, which applied the general
theory of price controls to the special case of money, demonstrated its validity. Eventually, efforts were abandoned to reach
the ideal of a bimetallic standard. The next goal then became to
free international trade, which was growing more and more
important, from the effects of fluctuations in the ratio between
the prices of the gold standard and the suppression of the alternating [bimetallic] and silver standards. Gold then became the
world’s money.
With the attainment of gold monometallism, liberals believed
the goal of monetary policy had been reached. (The fact that
they considered it necessary to supplement monetary policy
through banking policy will be examined later in considerable
detail.) The value of gold was then independent of any direct
manipulation by governments, political policies, public opinion
or Parliaments. So long as the gold standard was maintained,
there was no need to fear severe price disturbances from the side
of money. The adherents of the gold standard wanted no more
than this, even though it was not clear to them at first that this
was all that could be attained.

We have seen how the purchasing power of gold has continuously declined since the turn of the century. That was not, as
frequently maintained, simply the consequence of increased gold
production. There is no way to know whether the increased production of gold would have been sufficient to satisfy the
increased demand for money without increasing its purchasing
power, if monetary policy had not intervened as it did. The gold
exchange and flexible standards were adopted in a number of
countries, not the “pure” gold standard as its advocates had

Monetary Stabilization and Cyclical Policy — 95

expected. “Pure” gold standard countries embraced measures
which were thought to be, and actually were, steps toward the
exchange standard. Finally, since 1914, gold has been withdrawn
from actual circulation almost everywhere. It is primarily due to
these measures that gold declined in value, thus generating the
current debate on monetary policy.
The fault found with the gold standard today is not, therefore,
due to the gold standard itself. Rather, it is the result of a policy
which deliberately seeks to undermine the gold standard in order
to lower the costs of using money and especially to obtain “cheap
money,” i.e., lower interest rates for loans. Obviously, this policy
cannot attain the goal it sets for itself. It must eventually bring
not low interest on loans but rather price increases and distortion
of economic development. In view of this, then, isn’t it simply
enough to abandon all attempts to use tricks of banking and
monetary policy to lower interest rates, to reduce the costs of
using and circulating money and to satisfy “needs” by promoting
paper inflation?
The “pure” gold standard formed the foundation of the monetary system in the most important countries of Europe and
America, as well as in Australia. This system remained in force
until the outbreak of the World War [1914]. In the literature on
the subject, it was also considered the ideal monetary policy
until very recently. Yet the champions of this “pure” gold standard undoubtedly paid too little attention to changes in the
purchasing power of monetary gold originating on the side of
money. They scarcely noted the problem of the “stabilization” of
the purchasing power of money, very likely considering it completely impractical. Today we may pride ourselves on having
grasped the basic questions of price and monetary theory more
thoroughly and on having discarded many of the concepts which
dominated works on monetary policy of the recent past.
However, precisely because we believe we have a better understanding of the problem of value today, we can no longer
consider acceptable the proposals to construct a monetary system based on index numbers.

96 — The Causes of the Economic Crisis

It is characteristic of current political thinking to welcome every
suggestion which aims at enlarging the influence of government. If
the Fisher and Keynes27 proposals are approved on the grounds
that they are intended to use government to make the formation of
monetary value directly subservient to certain economic and political ends, this is understandable. However, anyone who approves of
the index standard, because he wants to see purchasing power “stabilized,” will find himself in serious error.
Abandoning the pursuit of the chimera of a money of
unchanging purchasing power calls for neither resignation nor
disregard of the social consequences of changes in monetary
value. The necessary conclusion from this discussion is that stability of the purchasing power of the monetary unit presumes
stability of all exchange relationships and, therefore, the absolute
abandonment of the market economy.
The question has been raised again and again: What will
happen if, as a result of a technological revolution, gold production should increase to such an extent as to make further
adherence to the gold standard impossible? A changeover to the
index standard must follow then, it is asserted, so that it would
only be expedient to make this change voluntarily now.
However, it is futile to deal with monetary problems today
which may or may not arise in the future. We do not know
under what conditions steps will have to be taken toward solving them. It could be that, under certain circumstances, the
solution may be to adopt a system based on an index number.
However, this would appear doubtful. Even so, an index standard would hardly be a more suitable monetary standard than
the one we now have. In spite of all its defects, the gold standard
is a useful and not inexpedient standard.


1923 proposal, A Tract on Monetary Reform.

Monetary Stabilization and Cyclical Policy — 97





tabilization” of the purchasing power of the monetary unit
would also lead, at the same time, to the ideal of an economy without any changes. In the stationary economy there
would be no “ups” and “downs” of business. Then, the sequence
of events would flow smoothly and steadily. Then, no unforeseen
event would interrupt the provisioning of goods. Then, the acting individual would experience no disillusionment because
events did not develop as he had assumed in planning his affairs
to meet future demands.
First, we have seen that this ideal cannot be realized. Second,
we have seen that this ideal is generally proposed as a goal only
because the problems involved in the formation of purchasing
power have not been thought through completely. Finally, we have
seen that even if a stationary economy could actually be realized,
it would certainly not accomplish what had been expected. Yet
neither these facts nor the limiting of monetary policy to the
maintenance of a “pure” gold standard mean that the political slogan, “Eliminate the business cycle,” is without value.
It is true that some authors, who dealt with these problems,
had a rather vague idea that the “stabilization of the price level”
was the way to attain the goals they set for cyclical policy. Yet

98 — The Causes of the Economic Crisis

cyclical policy was not completely spent on fruitless attempts to
fix the purchasing power of money. Witness the fact that steps
were undertaken to curb the boom through banking policy, and
thus to prevent the decline, which inevitably follows the upswing,
from going as far as it would if matters were allowed to run their
course. These efforts—undertaken with enthusiasm at a time
when people did not realize that anything like stabilization of
monetary value would ever be conceived of and sought after—led
to measures that had far-reaching consequences.
We should not forget for a moment the contribution which
the Currency School made to the clarification of our problem.
Not only did it contribute theoretically and scientifically but it
contributed also to practical policy. The recent theoretical treatment of the problem—in the study of events and statistical data
and in politics—rests entirely on the accomplishments of the
Currency School. We have not surpassed Lord Overstone28 so far
as to be justified in disparaging his achievement.
Many modern students of cyclical movements are contemptuous of theory—not only of this or that theory but of all
theories—and profess to let the facts speak for themselves. The
delusion that theory must be distilled from the results of an
impartial investigation of facts is more popular in cyclical theory
than in any other field of economics. Yet, nowhere else is it
clearer that there can be no understanding of the facts without
Certainly it is no longer necessary to expose once more the
errors in logic of the Historical-Empirical-Realistic approach to
the “social sciences.”29 Only recently has this task been most thoroughly undertaken once more by competent scholars.
Nevertheless, we continually encounter attempts to deal with the
business cycle problem while presumably rejecting theory.

Samuel Jones Loyd Overstone (1796–1883) was an early opponent of inconvertible paper money and a leading proponent of the
principles of the Peel’s Act of 1844.—Ed.]
29[See Theory and History (1957; 1969; Auburn, Ala.: Ludwig von Mises
Institute, 1985).—Ed.]