In a Wall Street Journal op-ed today, Hoover Institution Senior Fellow John H. Cochrane expresses his concern over the fact that some of President Trump’s potential nominees to the Fed’s Board of Governors have shown sympathy for a monetary system grounded in a gold standard. (John H. Cochrane, “Forget the Gold Standard and Make the Dollar Stable Again,” 1/18/2019) He argues that historical evidence shows that the gold standard the U.S. once had did not live up to the claims that current proponents of a return to such a monetary system make. He says that the evidence is that the gold standard prevented neither inflation nor deflation. Because of this history, Mr. Cochrane proposes a “CPI standard” as a rules-based means to determine monetary policy. Under this standard, the Fed would keep the CPI closely in line with a particular (and constant) value. He asserts that such a standard would be an improvement over the Fed’s current no-rules discretionary decision-making.

In my view, however, even if there were an improvement, it would be at best marginal and could result in undesirable outcomes under certain circumstances. The reason is because Mr. Cochrane’s proposal suffers from the same flaw that characterizes the rest of macroeconomics, namely a focus on aggregates and averages.  Such a focus neglects the significance of the underlying microeconomic variables that determine the path and composition of economic activity, including actual prices in individual markets.  So, for example, should significant productivity gains owing to technological advances or capital improvements take place across all economic sectors, the general price level should fall.  Such price deflation is neither a consequence of slowing economic activity nor indicative of the need for a policy response.  Yet, under the CPI standard unnecessary price inflation would have to occur to maintain the stability of the index.  An even worse scenario would occur if productivity gains are not spread evenly but instead are specific to certain of the index’s components.  In this situation, policies to keep the index stable risk inflating prices to bubble levels in those sectors for which there has been little or no productivity improvement in underlying microeconomic markets.  Moreover, relative prices would likely be distorted to the detriment of economy-wide allocative efficiency.  Perhaps, as Mr. Cochrane argues, returning to some form of gold standard is not workable under 21^st Century conditions, but replacing discretionary policy with a CPI standard would also have its problems.