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Welcome to USAGOLD's "Gilded Opinion" pages. We invite you to browse our index of outstanding gold-based commentary. Each article or essay is selected on the basis of its long-term relevance for understanding the role gold plays in the individual's portfolio, the overall political economy, or both.
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(A Biography) Nobel Laureate Robert Mundell: 'Ahead of his Time'
by Laura Wallace of the IMF
Robert Mundell, a pioneer of modern international economics, received the Nobel Prize in 1999 for his analysis of monetary and fiscal policy under different exchange rate regimes and his analysis of optimum currency areas. He speaks to F&D about exchange rates, the euro, his work in China, and his castle in Italy.
...Mundell believes that, in a world where war is a possibility, an international monetary system based on a fiat world currency wouldn't work unless it were backed by one or more of the precious metals.
Gold could still be used as a reserve asset in a reformed international monetary system in the 21st century, but it would be a far cry from the international gold standard that prevailed before World War I. ... "There was nothing fundamentally wrong with the kind of monetary system we had in the postwar world."
It was a system in which other countries fixed their currencies to the dollar, while the U.S. fixed the price of gold. ... Mundell argues that the system broke down in the early 1970s because the U.S. rejected the idea of increasing the price of gold -- and thus made gold's relationship with the dollar untenable -- not because fixed [currency] exchange rates were wrong. In fact, had the U.S. revalued gold, the system could have sailed along for another two or three decades.
When Robert Mundell received the
Nobel Prize in economics in 1999,
the Royal Swedish Academy of Sciences cited his "uncommon-almost
prophetic-accuracy in predicting the future development of international
monetary arrangements and capital markets" back in the 1960s.
He's widely regarded as a pioneer of modern international economics.
In the same field, he's the economist who developed the modern
theory of optimal currency areas, and many observers include him
among the fathers of the euro.
Mundell's Nobel Prize had long been expected and was welcomed
by his peers. Maurice Obstfeld commented at a 2000 IMF conference
honoring the former IMF economist that, had Mundell's achievement
been entirely technical, it might have had little impact. "Instead,
through a rare combination of analytical power and Schumpeterian
'vision,' Mundell distilled from his mathematical formulations
important lessons that permanently changed the way we think about
the open economy." Michael Mussa-a student of Mundell's at
the University of Chicago and later IMF Economic Counsellor and
head of research-tells F&D that Mundell's enormous
impact on the field came about "not because of any single
idea but because of the approach he took to thinking about international
economics." He notes that Mundell was "in the forefront
of the analysis of the importance of international capital movements
and its role in international economic interactions."
Although the Canadian-born economist's work during the 1960s has
now become mainstream, a number of policies that he's advocated
at various times have not been embraced by the vast majority of
his peers. These include his call for a return to a gold standard
when U.S. inflation hit double digits in 1980; a return to the
postWorld War II (194671) Bretton Woods fixed exchange
rate system, modified to correct its defects; and the creation
of a global currency. Even his championing of "supply side"
tax cuts, which gained most attention during the Reagan administration
and made him a hero of U.S. political conservatives, has puzzled
many economists. Most recently, his outspoken advice to China
on its exchange rate regime is causing unease among policymakers
in the major industrial countries and their advisors at international
organizations like the IMF.
Is there an inconsistency between pioneering modern international
macroeconomics and supporting so many non-mainstream notions?
Mussa says no. "Bob has always been an enormously stimulating
and unorthodox thinker. So there has been a consistency. His contributions
were related partly to his willingness to think outside the box."
Actually, Mundell doesn't see himself as a maverick economist,
insisting that his work has stayed steadfastly in the tradition
of the great economists from Adam Smith through the founders of
the IMF, including Keynes, who believed in fixed exchange rates
based either on gold or on a world currency. As for the issues
on which he doesn't garner much peer support, he doesn't mind
being in the minority. And he doesn't object to The Economist
magazine's portrayal of him as "the great eccentric."
Little surprise that he serenaded his Nobel Prize banquet guests
in 1999 with the fourth verse of Frank Sinatra's signature song
"My Way."
A stint at the IMF
Mundell was born in 1932 in Kingston, Ontario, where he started
his academic life in a one-room schoolhouse. He received his bachelor's
degree in 1953 from the University of British Columbia in Vancouver,
with a joint major in economics and Slavonic studies. For his
graduate work, he did a year at the University of Washington in
Seattle, then a year at the Massachusetts Institute of Technology
(MIT), where he was influenced by Paul Samuelson and Charles Kindleberger.
Then he spent a year at the London School of Economics (attracted
by the work of Lionel Robbins and James Meade), where he finished
his Ph.D. thesis for MIT in 1956 on international capital movements
under the supervision of James Meade-who had recently published
his classic, pioneering books on the theory of international economic
policy (which won him a joint Nobel Prize in 1977)-and with advice
from fellow Canadian Harry Johnson. After that, he was a postdoctoral
fellow for a year at the University of Chicago.
Over the next few years, Mundell taught at the University of British
Columbia, Stanford University, and the Johns Hopkins Bologna Center
of Advanced International Studies in Italy (where his lifelong
love affair with Italy first took root). He lectured and published
papers on international trade, optimum currency areas, and monetary
and fiscal policy trade-offs under fixed and floating exchange
rates-attracting the attention of the IMF's Research Department,
then headed by Jacques Polak. Polak recalls going to great lengths
to recruit Mundell, whom he considered "courageous"
for studying floating exchange rates at a time when the topic
was "taboo."
One of Mundell's first assignments during his two-year stay (196163)
at the IMF was to address the problem of the appropriate mix of
fiscal and monetary policy, a subject that was being debated with
respect to the United States. The result was the paper "Appropriate
Use of Monetary and Fiscal Policy for Internal and External Stability,"
which refuted the prevailing U.S. doctrine of easy money to lower
long-term interest rates and a budget surplus to siphon off inflationary
pressure. "I argued that, under fixed exchange rates, monetary
policy had to be devoted to the balance of payments and fiscal
policy to stimulating the economy," he explains. "This
caused a revolution in thinking about the policy mix," he
says, leading to the reversal of the U.S. economic policy mix
and the 1964 tax cuts. He says that it was a critique of this
paper by economists at the U.S. Federal Reserve Board that led
him to an even stronger assumption of perfect capital mobility.
Mundell also worked on the theory of inflation, showing that,
contrary to the theories of Irving Fisher and Abba Lerner, an
increase in expected inflation would raise interest rates, but
by less-later known as the Mundell-Tobin effect. And he worked
on the monetary approach to the balance of payments, a subject
that Polak had pioneered. Mundell says he developed a theoretical
framework that was the foundation of an alternative to the Keynesian
framework for balance of payments equilibrium. He notes that it
was further developed by his University of Chicago students, including
the late Rudi Dornbusch, Jacob Frenkel, and Mussa, all of whom
later influenced the IMF.
Mundell considers his major breakthrough to be his 1960 journal
article that introduced a model of an economy dominated by two
markets: one for goods and services and one for foreign exchange.
Before that, he says, there weren't any models of what today we
call international macroeconomics. Many spin-offs followed, including
the Mundell-Fleming framework (also named after his IMF colleague,
Marcus Fleming, a British citizen, who had been working along
similar lines independently). The model shows that under a floating
rate and perfect capital mobility, monetary policy becomes powerful,
and fiscal policy powerless, in affecting output, whereas the
opposite is true when the exchange rate is fixed. It also shows
that if a country has a fixed exchange rate, it cannot in the
long run have an independent monetary policy, and that if it has
an independent monetary policy, it cannot have fixed exchange
rates. This result holds whether or not there is capital mobility.
Indeed, he considers that the "impossible trinity,"
which implies that a country can have a fixed exchange rate and
an independent monetary policy if it also has capital controls,
is erroneous. And making matters worse, in his view, the trinity's
"irrelevant focus on capital movements has been the spurious
raison d'etre of the shift in the 1970s to flexible exchange rates."
In Mundell's Nobel citation, the academy praised
him for establishing "the foundation for the theory which
dominates practical policy considerations of monetary and fiscal
policy in open economies." It said that his work on monetary
dyna-mics and optimum currency areas had inspired generations
of researchers. His analysis of the appropriate policy mix anticipated
the idea that the central bank should be given decentralized responsibility
for price stability-the case now in most countries. On exchange
rates, he posed a new and fundamental question: in what circumstances
is it advantageous for a number of countries to relinquish an
independent monetary policy or even their monetary sovereignty
to join a monetary union or a fixed exchange rate international
monetary system?
Europe's currency area
Mundell's insights into currency area formation were later used
to create a common currency in Europe. Did Europe fit the definition
of an optimum currency area? For him, the answer turned on factor
mobility, modified by the need to utilize as fully as possible
the convenience of money as a unit of account and a medium of
exchange. Although Europe didn't meet all of his stated criteria
(such as high labor mobility), he has been a stalwart supporter
(see box). And he insists that the monetary union has been a great
success. "Some say that Europe has performed badly compared
with the U.S. over the past 10 years, but they forget that Europe
has zero population growth and that European per capita income
growth isn't much below the U.S. figure."
He also stresses that the euro was never expected to be a panacea.
Like many others, he believes that much of Europe has overindulged
in its social model, relying on high, steeply progressive tax
rates and protective labor laws. Does he think part of the euro
area's problem hinges on its lack of labor mobility? "Labor
mobility is an important escape valve," he says, "but
it isn't the end-all of the theory of optimum currency areas.
Even if every European were completely immobile, rooted in one
place, it wouldn't mean that Europe should have 300 million currencies,
one currency for each person!"
But he does acknowledge that the European Union (EU) has suffered
a setback as a result of the recent French and Dutch votes against
the proposed new constitution, although he sees this as a signal
to develop a better political model-not a disaster. "Maybe
it isn't possible to create a European government that is modeled
after an existing government. Academic political scientists, including
well-wishers for Europe all over the world, may have to invent
something new, a new political structure for Europe." As
the EU absorbs its 10 new members, with lower-than-average per
capita incomes, he says, there will be growing pains and a need
for an interim system of government for a colossus of 25 nations.
"But it will be achieved because, for Europe, it isn't just
the best game in town, it's the only game."
More monetary unions
How about the rest of the world? Actually, if Mundell could have
his way, the entire world would be one big optimum currency area,
sharing a global currency. But he admits that political rivalries
make it difficult for this to happen because a necessary condition
for the creation of a monetary union-global or otherwise-is the
creation of a security area. He believes that, in a world where
war is a possibility, an international monetary system based on
a fiat world currency wouldn't work unless it were backed by one
or more of the precious metals. Gold could still be used as a
reserve asset in a reformed international monetary system in the
21st century, but it would be a far cry from the international
gold standard that prevailed before World War I.
So where does that leave us? Mundell would be thrilled if the
governors of the IMF would give more thought to finding an arrangement
to get back to the goals of Bretton Woods. "There was nothing
fundamentally wrong with the kind of monetary system we had in
the postwar world." It was a system in which other countries
fixed their currencies to the dollar, while the U.S. fixed the
price of gold. Gold was convertible but only for foreign monetary
authorities. Mundell regards it as having been an ingenious accommodation
to the reality of the United States as an economic superpower.
In that regard, he quotes Joan Robinson as having once called
the IMF an "episode in the history of the dollar." Mundell
argues that the system broke down in the early 1970s because the
U.S. rejected the idea of increasing the price of gold-and thus
made gold's relationship with the dollar untenable-not because
fixed exchange rates were wrong. In fact, had the U.S. revalued
gold, the system could have sailed along for another two or three
decades. Mundell believes the best way for a smaller country to
achieve monetary stability is to fix its currency to a large and
stable currency area. He also feels that the IMF is playing a
"divisive role" by encouraging countries to move to
flexible exchange rates, "balkanizing the monetary world
into a ridiculously large number of tiny currency areas."
Mundell argues that the best system for both small and large countries
would be a stable international monetary system based on fixed
exchange rates. A second-best, interim, arrangement would be for
the smaller countries to fix credibly to the dollar or the euro,
in this way participating in the stability of the larger currency
area. However, the solution would be even better if a basket of
the dollar, the euro, and the yen-what he calls the DEY-were to
become the nucleus of a new global currency issued by a revamped
IMF.
He also supports a strong multilateral surveillance role for the
IMF-particularly, closely monitoring global economic developments
to spot potential crises and to try to fend them off. But he doesn't
want surveillance to become a code for giving the IMF power to
determine exchange rates in a world without an international monetary
system. And he disagrees strongly with what he regards as global
pressure to force China to appreciate its currency-insisting that
a large yuan appreciation wouldn't help resolve global current
account imbalances, but would devastate China, causing drastic
deflation, impoverishing the rural sector, and cutting its growth
rate by as much as half. Mundell hopes China will keep its exchange
rate fixed to the dollar while continuing to move toward currency
convertibility. And he hopes it will turn its attention to huge
challenges in health, education, the environment, and agriculture.
As for reducing the income divergence between rural and urban
China, he says, the best plan would be "to give the farm
people the same rights to own property that city people have."
The Palazzo Mundell
What is Mundell up to these days? Given his fascination with China-its
people and the pivotal role that the giant economy has begun to
play in the global economy-he has recently become a "citizen"
of the Municipality of Beijing, a legal nicety (no visa needed
to enter and exit China) that facilitates his considerable involvement
in the country's economics, education, and even business. He's
an honorary professor at 30 universities in China and an honorary
dean, president, or chairman of several research institutes. He
has set up some scholarships for students, founded the "Best
Young Economist" award, and turned over the royalties from
his six-volume Collected Works in Chinese to fund a literature
award. A new university has just been named after him (the Mundell
International University of Entrepreneurship) in Beijing's Zhongguancun
area, known as the "Silicon Valley of China."
| A defense
of the euro Despite recent troubles in the euro area on a number of economic policy fronts and questions about whether the creation of the currency has been worthwhile, Mundell fiercely defends its track record. "In all the aspects in which it was expected economically to make an improvement, it has performed spectacularly." He argues that every citizen in the euro area has a better currency than before, one that vies with the dollar in its prestige and stability. Every firm now has access to a capital market that is continental in scope. With the elimination of exchange rate uncertainty between members of the euro area, there aren't any more speculative capital movements within the euro area, and interest rates have become equalized. (Note that instead of double-digit interest rates for many of the countries, they are now at or below 5 percent.) Every country in the euro area has a better monetary and fiscal policy mix than before. The possibility of a surprise inflation-cum-devaluation has been ruled out, and hedge funds can't make a dime between euro countries. And information and transaction costs have plummeted, Mundell says, clearing a path for a vast increase in the most beneficial type of intra-area trade and payments. |
He also stays strongly rooted
in academia, much beloved by generations of students who have
deeply valued how much he has been willing to give of himself
to help them grow. He was a professor at the University of Chicago
(where he was also Editor of the Journal of Political Economy)
from 1966 to 1971-a time famous for its economic talents, including
several other future Nobel Prize winners. "As a teacher,
he was both stimulating and irritating," says Mussa, explaining
that Mundell liked to tease his students with "intelligent
questions that weren't entirely well structured and therefore
didn't have clear answers." Since 1974, he has been a professor
at Columbia University.
David Bloom, Harvard professor of economics and demography and
a former Columbia colleague, recalls that the most interesting
conversation he ever had with Mundell was about the effect of
cross-country demographic imbalances (in age) on international
capital flows-a topic that Mundell isn't normally associated with
but finds enormously important for macroeconomic performance.
In fact, Mundell developed a four-generation model that shows
that if one country has a demographic shock, it creates a wave
of interest rate changes that bring on, in an open economy, compensating
capital movements. The model also highlights the role that the
U.S. baby boom has played in U.S. balance of payments and budget
deficits, as there was high demand for resources (some of which
were internally generated and some of which flowed in from abroad)
associated with investing in children.
Plus, he continues to do research. Mundell says finding a way
to stop inflation without bringing on a crisis tops his list.
As he explains it: "Disinflation under inflation targeting
works by monetary restriction, higher interest rates, returning
confidence, capital inflows, current account deficits, and an
appreciating currency. The appreciating currency then fosters
more disinflation and helps the country to meet its new inflation
targets. But after the new low-inflation equilibrium has been
reached, the currency is overvalued and recognition of this brings
on a speculative crisis."
When Mundell isn't in Manhattan or Beijing-or traveling around
the world lecturing and advising policymakers or international
institutions-he and his family (wife Valerie, 8-year-old son Nicholas,
and three children from a previous marriage) find refuge in the
12th-century castle in Siena, Italy, that he bought in 1969 for
only $20,000 as a hedge against inflation. It is here, at the
"Palazzo Mundell," that he organizes yearly academic
conferences-begun in the early 1970s-on the burning economic issues
of the day. And it is here that he can relax and enjoy the finer
things in life, like art and music (especially opera).
When Mundell received $975,000 for the Nobel, he announced that
most of it would go to restoring his Italian villa, which initially
lacked running water and electricity. He estimates that the restoration
is 75 percent finished. "That's enough. We have to leave
something for the next generation to do," he says, and he
hopes that, besides finishing the restoration project, his children
will make their mark in life "their way." But just to
make sure little Nicholas gets a head start, he's being tutored
in Chinese.
Laura Wallace is Editor-in-Chief of Finance &
Development, a quarterly magazine of the IMF
from F&D -- September 2006, Volume 43, Number 3
http://www.imf.org/external/pubs/ft/fandd/2006/09/people.htm
Finance & Development's print editions are published
quarterly in English, Arabic, Chinese, French, and Spanish-and
its World Wide Web edition is published quarterly in English,
French, Russian and Spanish-by the International Monetary Fund, 700 19th Street,
N.W., Washington, DC 20431, U.S.A.
Opinions expressed in articles and other materials are those of
the authors; they do not necessarily reflect IMF policy.
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