The Interwar Revolution in Monetary Thinking: Internal Stability, Full Employment, and NO Regard to the Balance of Payments

Stripped of technicalities and of short-run considerations the controversy over exchange rates: fixed or flexible, is essentially an aspect of the broader controversy over international economic integration (on the basis of the price mechanism and a common standard of value) as opposed to economic nationalism. The latter takes the form, in the area of monetary relations, of concern over a country’s ‘monetary independence’. Flexible or floating exchange rates have, in the opinion of their advocates, the great virtue of allowing a country (i.e. a government) to adopt an internal monetary, financial and, indeed, economic policy without concern for balance-of-payments equilibrium. As Professor Friedrich A. Lutz wrote in the December 1954 issue of the Banca Nazionale del Lavoro Quarterly Review: ‘The main advantage that can be claimed for a policy of flexible exchange rates is that it allows a country both to avoid quantitative import controls and to follow . . . an “independent” monetary policy, i.e. a policy that is unaffected by deficits or surpluses in its balance of payments.’

Several years ago, writing in the same vein, Professor Alvin H. Hansen of Harvard University spoke of a revolution in monetary thinking: ‘In the interwar decades a new standard of monetary policy increasingly won its way—emancipation from the adjustment process dictated by the gold standard; freedom to pursue a programme of internal stability and full employment without regard to the balance of payments.’ I have italicized the last words of the quotation; they express, as does the earlier quotation from Professor Lutz, one of the widespread and yet very fallacious aspirations of certain governments (their number has happily shown a substantial decline of late) and of altogether too many learned economists, aspiration to ‘do as one pleases’ without suffering any adverse consequences. A very human aspiration indeed—but also one that has been proved time and again to be unattainable—and one in which it is rather unwise to persevere.

—Michael A. Heilperin, “Fixed Parities and International Order (1955),” in Aspects of the Pathology of Money: Monetary Essays from Four Decades (Auburn, AL: Ludwig von Mises Institute, 2007), Ludwig von Mises Institute e-book.