Central Banks and the Monetary Games They Play: On the Inflationist Doctrine of “Lowering Interest Rates”

Countries around the world became involved in monetary games like the “stop-go” policies of Britain, in which an attempt to “lower interest rates” (the “go” period) would result in a small inflationary boom and a sagging value of the pound. At that point, to maintain the Bretton Woods system’s fixed exchange rates, the central bank would then have to engineer a monetary contraction (the “stop” period) to support the currency. It was the same thing that the Bank of England had done in 1825. But while the Bank of England had recognized its accidental mistake in 1825, the young inflationists did the same thing on purpose. The stop period would of course tend to be recessionary, which only created an impetus for another go period of excessive monetary expansion and fueled the inflationists’ dreams of what would be possible if they weren’t bound by the “golden fetters” of the Bretton Woods system. . . . 

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The inflationists at times gained the upper hand over the discipline of the Bretton Woods peg. In the late 1940s in Britain, the authorities argued that “lowering interest rates” would make it cheaper to service the national debt, and they embarked on a program of keeping short-term rates at a tiny 0.5 percent. This is almost exactly the game the Federal Reserve had been pressured into playing in 1919. The Fed called a halt to the charade—it was involved in similar foolishness in the late 1940s as well, before pulling back again—but the Brits carried it through to its logical conclusion. The pound was devalued from $4.03 to $2.80 on September 18, 1949. The existing national debt did indeed become cheaper to service, since the government essentially defaulted on much of it through the mechanism of devaluation. 

The end result of all this “lowering interest rates” throughout the world was in fact a persistent rise in interest rates after World War II, as lenders demanded an extra premium to protect themselves against the risk of devaluation and inflationary default (which is exactly what happened).

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The result of the continuing dominance of the gold standard through the Bretton Woods system was that the inflationist doctrine of “lowering interest rates” was never fully debunked, and instead completely saturated the academic economics establishment. The principles of economics upon which the gold standard was founded were scrubbed clean from textbooks after World War II. Frustrated by the inability to carry out their policies to their conclusion, the descendants of Keynes instead strengthened their position by indoctrinating two generations of economists to their way of thinking.

—Nathan Lewis, Gold: The Once and Future Money (Hoboken, NJ: John Wiley and Sons, 2007), 202-204.