The institutional “golden fetters” of the interwar period have been replaced by fundamental “global fetters” that severely constrain monetary policy.
While Federal Reserve Chair Jay Powell’s speech at the Jackson Hole Economic Policy Symposium last week didn’t break any new ground other than confirming market pricing for further near-term rate cuts, several academic papers presented at the symposium and Bank of England Governor Mark Carney’s luncheon speech provided deeper insights into global monetary linkages that have become an increasing headache for central bankers both in the U.S. and elsewhere. While a brief blog post won’t do justice to all of these contributions, here are my main takeaways.
Some historical perspective first: Largely thanks to UC Berkeley scholar Barry Eichengreen’s work culminating in his masterful 1992 book, “Golden Fetters: The Gold Standard and the Great Depression, 1919–1939,” it is widely understood how the international gold standard, as reconstructed after World War I, constrained domestic monetary policies in the participating countries, transmitted destabilizing influences from the U.S. to the rest of the world in the late 1920s, and helped set the stage for the Great Depression of the 1930s.
‘Golden fetters’ give way to ‘global fetters’
Obviously, no such rule-based constraints for monetary policy exist in today’s international monetary system of fiat currencies and flexible exchange rates. So, in theory, central banks are free to pursue domestic monetary policy independently of each other in their pursuit of domestic stability.
In reality, however, central banks today increasingly face other limitations: The institutional “golden fetters” of the interwar period have been replaced by fundamental “global fetters” that severely constrain monetary policy.
These shackles reflect 1) the role of the U.S. dollar as the dominant international currency, and 2) the increasing influence of the global equilibrium interest rate (r*) on domestic r*. Unlike the “golden fetters,” the “global fetters” are unlikely to cause a Great Depression, but they have the potential to act as a further drag on both the global and the U.S. economy, particularly if the Fed does not take them sufficiently into account fast enough.