Author: Bas van de Mortel
April 6, 2021

What if the gold standard would have been in place in 2000-2020? A working paper released in October 2020 shows us how our macroeconomic world would look like if we would have returned to the gold standard in 2000. 

The gold standard was the standard monetary system in the 19th and early-20th century world and based on a fixed quantity of gold (the use of gold as money itself, on the other hand, existed for thousands of years before the establishment of the formal system). World War I caused several governments to abandon the gold standard to be able to wage the war. After the war, the charm of it resulted in central bankers who wanted to go back to gold, at the cost of their own citizens. With the British Gold Standard Act of 1925, the UK turned back to the gold standard, leading to depression and unemployment. At the end of the second world war, a new international system was designed, the Bretton Woods order. With the dollar tied to gold, and other key currencies tied to the dollar. When that broke down at the start of the 1970s, the world moved on to a fiat system where the dollar was not backed by a commodity, and was therefore not anchored. 

If the charm of the gold standard would catch us today as well, the prospects are as bad as Keynes predicted and told Churchill after the first world war. If the gold standard had been in place as of 2000, this would have meant that the Fed should set the interest rates to maintain a fixed dollar price of gold instead of targeting inflation. The interest rates would depend on the supply of gold; it would depend on mining activities and the demand of gold by investors and households. 

Next to that, monetary policy could become procyclical. In bad times, the demand for gold increases generally. The central bank would then have to raise the interest rates to stabilize the price of gold. On the contrary, the central bank would have to cut the rates if the demand for gold decreases, mostly in good times. Furthermore, monetary policy would become rather unpredictable because of the randomness of finding new gold mines and the resulting volatility of supply of gold. 

Only with assumptions far from reality, such as the supply of gold tracking productivity, the gold standard could beat today’s monetary policy regime. The authors of the working paper expect that the output of the first half of 2020 would be about 10% lower if the gold standard would have been implemented from 2000 until 2020 and in the global financial crisis the Fed would have had to maintain high interest rates. Not such a good standard, the gold standard.

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