Mundell's Nobel Prize Speech

Written by Ralph J. Benko

Thursday, July 26, 2012

"The international gold standard at the beginning of the 20^th century operated smoothly to facilitate trade, payments and capital movements."  -- Robert Mundell

"The Royal Swedish Academy of Sciences awarded the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel, 1999, to Professor Robert A. Mundell, Columbia University, New York, USA for his analysis of monetary and fiscal policy under different exchange rate regimes and his analysis of optimum currency areas. ...  Robert Mundell has established the foundation for the theory which dominates practical policy considerations of monetary and fiscal policy in open economies. His work on monetary dynamics and optimum currency areas has inspired generations of researchers. Although dating back several decades, Mundell's contributions remain outstanding and constitute the core of teaching in international macroeconomics.  Mundell's research has had such a far-reaching and lasting impact because it combines formal - but still accessible - analysis, intuitive interpretation and results with immediate policy applications. Above all, Mundell chose his problems with uncommon - almost prophetic - accuracy in terms of predicting the future development of international monetary arrangements and capital markets. Mundell's contributions serve as a superb reminder of the significance of basic research."

Prof.  Mundell, in his speech accepting this distinguished award, stated:

The international gold standard at the beginning of the 20^th century operated smoothly to facilitate trade, payments and capital movements. Balance of payments were kept in equilibrium at fixed exchange rates by an adjustment mechanism that had a high degree of automaticity. The world price level may have been subject to long-terms trends but annual inflation or deflation rates were low, tended to cancel out, and preserve the value of money in the long run. The system gave the world a high degree of monetary integration and stability.

International monetary systems, however, are not static. They have to be consistent and evolve with the power configuration of the world economy. Gold, silver and bimetallic monetary standards had prospered best in a decentralized world where adjustment policies were automatic. But in the decades leading up to World War I, the central banks of the great powers had emerged as oligopolists in the system. The efficiency and stability of the gold standard came to be increasingly dependent on the discretionary policies of a few significant central banks. This tendency was magnified by an order of magnitude with the creation of the Federal Reserve System in the United States in 1913. The Federal Reserve Board, which ran the system, centralized the money power of an economy that had become three times larger than either of its nearest rivals, Britain and Germany. The story of the gold standard therefore became increasingly the story of the Federal Reserve System.

World War I made gold unstable. The instability began when deficit spending pushed the European belligerents off the gold standard, and gold came to the United States, where the newly-created Federal Reserve System monetized it, doubling the dollar price level and halving the real value of gold. The instability continued when, after the war, the Federal Reserve engineered a dramatic deflation in the recession of 1920-21, bringing the dollar (and gold) price level 60 percent of the way back toward the prewar equilibrium, a level at which the Federal Reserve kept it until 1929.

It was in this milieu that the rest of the world, led by Germany, Britain and France, returned to the gold standard. The problem was that, with world (dollar) prices still 40 percent above their prewar equilibrium, the real value of gold reserves and supplies was proportionately smaller. At the same time monetary gold was badly distributed, with half of it in the United States. In addition, uncertainty over exchange rates and reparations (which were fixed in gold) increased the demand for reserves. In the face of this situation would not the increased demand for gold brought about by a return to the gold standard bring on a deflation? A few economists, like Charles Rist of France, Ludwig von Mises of Austria and Gustav Cassel of Sweden, thought it would. ...

Rist, Mises and Cassel proved to be right. Deflation was already in the air in the late 1920?s with the fall in prices of agricultural products and raw materials. The Wall Street crash in 1929 was another symptom, and generalized deflation began in 1930.

Mundell concluded his remarks:

The century closes with an international monetary system inferior to that with which it began, but much improved from the situation that existed only two-and-a-half decades ago. It remains to be seen where leadership will come from and whether a restoration of the international monetary system will be compatible with the power configuration of the world economy. It would certainly make a contribution to world harmony.