Comment on Robert Hall's "Controlling the Price Level"

American Journal of Economics and Sociology, The, Jan, 2005 by James Tobin

Fisher's idea was quite simple. It applies to a commodity, or "representative," currency as distinguished from fiat money. In Fisher's day, paper money and token coin were the predominant means of payment. The public exchanged them for real commodities, in other words, for goods and services for consumption or for the making of consumption goods. The value of currency in goods, v, was free to move in markets from day to day. The currency was at the same time redeemable by the government for one or more particular real goods, at an administratively set rates, x units of currency for one unit of a standard good. At these rates the government promised either to buy or sell. Both the United States and Britain set prices of their currencies in two standards, silver and gold, through most of the 19th century. But at the time Fisher was advocating the proposal Bob Hall is reviving today, silver had lost its status as a standard.

Fisher was concerned, therefore, with the value of gold in goods and services implied by gold's price at the mint, and the market value of gold in goods and services in production and trade as a commodity. Micro economic conditions determined this latter value. Let this value be g. Thus a consumer with currency could obtain a general real good, say the Consumer Price Index bundle, either by parting with 1/v units of currency in the currency-goods market, or by changing currency at the mint into enough gold to buy it, namely 1/g ounces. To obtain 1/g ounces of gold would cost the individual 1/gx in currency. In normal circumstances, with no advantage, no arbitrage incentive, to either route over the other, gx = v. However, Fisher thought the currency-goods market could and often would make v different from gx. Moreover, g itself could vary, leading to fluctuations in v, which Fisher wanted to stabilize, say at v = 1. So Fisher's proposal is periodically to set x - v/g, believing that the arbitrage between the two currency-to-goods channels are strong enough to set a new v equal to 1.

Although Fisher's proposal was not adopted as a routine of monetary stabilization, something like it has been do done on occasion, by altering the administered mint valuation of the currency relative to its commodity (gold) standard, usually by devaluations. In 1933 Fisher strongly advocated devaluation, increasing the dollar price of gold, long stuck at $20.67 per ounce, in other words, lowering the arbitrary setting of x. Fisher bombarded President Roosevelt with letters advocating this devaluation (he called it "revaluation"). Roosevelt was more strongly influenced by two Cornell agricultural economists, who assured FDR that ordinary farm prices would rise the same as the official increase in the price of gold, almost immediately. In 1933-34, the official dollars-to-gold price of gold at which the U.S. Treasury would make transactions was raised by 69.3%. Farm prices rose from 1933-35 53.2%, lending support to the claims of Warren and Pearson. However, as a more general macroeconomic proposition, closer to Fisher's objective, the result was less striking. Economy-wide prices rose only 9.2%. That was in fact fortunate, because it meant that the devaluation was a much-needed stimulus to economic activity, employment, and output, a more desirable outcome in Depression times than boosting prices. Indeed Fisher himself was thinking of price revaluation as a mechanism for quantitative recovery, which it could not have been if it completely absorbed the monetary stimulus to aggregate demand.

A favorite metaphor of Bob Hall is the idea that the government's designation of the unit of its currency in a standard commodity is an arbitrary definition, like the designation of weights and measures. These definitions are indeed prerogatives of the central government, and they are arbitrary, but there the resemblance stops. Fisher's proposal concerned a commodity standard currency in market economies in which standard money could be obtained either by offering currency to the government or by purchasing the standard commodity in ordinary trade in nongovernmental markets. There is nothing like that in the Bureau of Standards' definition of a yard in terms of particles.

Hall's paper diverges from Fisher when he tries to apply the Fisher model to fiat money. Certainly the government can say what paper and coin represent in fiat dollars, but that doesn't do anything to stabilize v, the commodity value of the fiat money. In the past, as Hall himself reminds us, he looked for a substitute for gold--a feasible collection of a few tradable durable commodities, whose value in representative goods and services, like the Consumer Price Index basket, would be reasonably stable. Then this could take the place of gold in the Fisher setup. But Bob couldn't find such a new standard. It turned out that Hall's proposed bundle was not a good mimic of the market's overall real bundle. He seems not to recognize that the Fisher proposal would not apply unless currency were exchangeable for the standard both at the mint and in ordinary markets. It's not enough to define a dollar as so much plywood unless private individuals are free to deal in plywood markets and are expected to deliver plywood if they have promised to deliver dollars. There would have to be more to the alchemy of plywood than definition alone, anyway.