Ron Paul, who now heads the House Financial Services Committee's subcommittee on monetary policy, has an important job. The Fed also has an important job, and a lot of power, and we want to know that we can trust them. Paul's job is to aid Congress in overseeing the Fed, in part by finding good expert witnesses to speak and answer questions in hearings, in order to shed light on what the Fed does and whether it is performing well.
Ron Paul is of course no friend of central bankers, and has written about putting the Fed out of business. Why? Paul is a libertarian, and is a follower of the "Austrian School," an essentially libertarian branch of economic thought, whose most prominent members were Ludwig von Mises and Freidrich Hayek. The Austrian School lives on as a fringe movement in the profession.
I don't know a lot about the Austrian School, but I have run across Hayek's ideas from time to time. The ideas are extreme, but not crazy. For example, Hayek's Denationalisation of Money, is a coherent argument for a monetary system with private money issue. Conventional economic wisdom is that, if we allow the private sector to issue money, then there is a market failure. Even Milton Friedman - an advocate of laissez faire in most respects - argued in A Program for Monetary Stability that the issue and control of the stock of money was the province of the government, so clearly Hayek's views were unusual.
However, what Hayek was advocating had in fact been put in practice historically in more than one instance. There was free banking (with currency issue by private banks) in Scotland in the early 19th century. The United States had private currency issue from 1837-1863 by state-chartered banks, and Canada had a system of private money before 1935. While the US free banking era (1837-1863) appears to have been quite chaotic (more so in some states than others) the experience with private money issue in Scotland and Canada appears to have been quite good. Canada, for example, went through the early part of the Great Depression with no bank failures, in spite of the fact that there was no central bank to act as lender of last resort.
There are legitimate questions economists should ask, and have asked, about the fundamental role of the central bank, and whether the issue of "money" should be essentially a government monopoly. Gary Gorton, Warren Weber, and Arthur Rolnick, for example, have studied the free banking era in the United States, and there is work in monetary theory, for example by Ricardo Cavalcanti and Neil Wallace, among others, on the role of private money in efficient monetary arrangements. Thus, some of the questions Hayek was interested in have been studied in rigorous economic frameworks.
Thus, the Austrians were libertarian, but not kooky, so the fact that Ron Paul is interested in Austrian economics does not make him a kook. But Ron Paul is also interested in the gold standard. I'm not sure where the Austrians stood on that, but the gold standard has certainly drawn its share of kooks. The gold standard was part of the natural evolution of monetary systems from exchange with pure commodity money to fiat standards. Commodity money is wasteful, in that it is costly to dig gold out of the ground for use as money, and gold has other uses, from which it has to be diverted if it is used in exchange. Gold is also heavy, and therefore costly to carry around in large quantities. If we are able to solve the counterfeiting problem inherent in exchange using paper currency, then we can save the costs of carrying gold around by backing the paper currency one-for-one with gold, with gold exchanging for currency at a fixed rate. We can go even further in resource savings with fractional backing of the currency by gold. Why not go even further and eliminate the backing altogether, and just trust the government to regulate the quantity of money in circulation? That's where our modern fiat money systems come from.
What case do gold bugs make for a return to the good old days of the gold standard? They argue that the government cannot be trusted. Governments, as they argue, will be tempted to use the printing press to finance government deficits, and the cost will be high inflation. The gold standard, whereby a government agency stands ready to buy and sell gold at a fixed price will, they argue, give us price stability. What's the problem with that? First there has to be a resource cost associated with this. In order to maintain a fixed price of gold in terms of central bank liabilities, the government would have to hold a reserve stock of the stuff. The relative price of gold would be higher than it would be otherwise, causing people to economize on it in alternative uses, and causing more of it to be dug out of the ground. Just as was the case historically, there would be waste, but perhaps this would be small. But the principal defect in the gold standard is that the relative price of gold fluctuates substantially, and would continue to fluctuate substantially under a gold standard. These fluctuations occur because of changes in mining technology, changes in the demand for gold in industrial and other uses, and because of the fact that gold is a store of wealth. It seems clear that the gold standard would give us more variability in prices, not less. Further, as was the case historically, a gold standard does not imply that the government is necessarily committed to anything. The government can always decide to change the price at which it buys or sells gold.
So, what has Ron Paul been up to in his role in leading the subcommittee on monetary policy? Well, not much good apparently. The subcommittee recently invited three economists to come to Washington to talk to them: Thomas DiLorenzo, Richard Vedder, and Josh Bivens. The first two are Austrian School types, and DiLorenzo is clearly a quack. Bivens writes pieces for the Economic Policy Institute on the state of the macroeconomy. This is certainly an undistinguished lot, and not the first names that come to my mind as experts on monetary policy.
To repeat, Ron Paul has an important job. We have been through some unusual experiences on the monetary and financial front. Our central bank has made the choice to engage in some unusual practices. The Fed's decisions need to be reviewed and analyzed, and Congress needs to determine whether the Fed did the right things, whether it did the wrong things but should be forgiven, or whether some additional constraints need to be placed on the Fed's behavior.
Currently, the Fed operates under a dual mandate set out in the Humphrey Hawkins Act, which contains vague language about how the Fed should view its influence over real activity and inflation. In some other countries, central banks don't operate that way, but instead negotiate an explicit inflation-targeting arrangement with the legislative branch. Why don't we do that? In any case, these issues should be discussed and debated in Paul's Committee.
But Ron Paul cannot make any headway on these important issues if his agenda is quack economics. My advice would be to ditch DiLorenzo and company and talk to some of these people (I'm assuming Bernanke is the only Fed person who can speak directly to Congress):
Mike Woodford, Columbia University
John Cochrane, University of Chicago
Mark Gertler, NYU
Gary Gorton, Yale
Arthur Rolnick, formerly Minneapolis Fed
Robert Lucas, University of Chicago
Inviting these people to speak to the subcommittee would at least capture the important ideas on monetary policy that are taken seriously at top research institutions in the profession.