Monetary Institutions and the Rule of Law

By Alexander W. Salter

A great inheritance of the Enlightenment political tradition is the rule of law. If a polity is governed by the rule of law rather than the whims of those with power, the rules individuals must follow are general, predictable, and nondiscriminatory. General rules apply to broad cases, giving individual actors a means to anchor their expectations and coordinate their actions. Predictable rules can be known in advance with a high degree of probability, which enables individuals to plan for the future. And nondiscriminatory rules do not benefit one class of the population at the expense of others, institutionalizing a basic degree of legal equality.

Modern political institutions are almost always judged, in part, according to whether they are compatible with the rule of law. Strangely, monetary institutions have rarely been held to this standard. The dominant monetary institution in existence is discretionary central banking. In this system, monetary-policy decision-makers are given wide scope for action to conduct monetary policy, according to their beliefs about the suitability of that policy to achieve macroeconomic goals. This results de facto in a whims-of-men system, not a rule-of-law system.

Admittedly, discretionary central banking might be acceptable on consequentialist grounds. Perhaps having a monetary system that adheres to the rule of law would result in great macroeconomic turbulence. Perhaps the least-bad system requires monetary-policy experts to have significant discretion to engineer desirable outcomes. 

But no such beneficial consequences exist. Discretionary central banking cannot deliver better macroeconomic outcomes than a rule-of-law system. Central bankers have strong incentives to make policy too loose in ordinary times and to be overly generous with emergency lending during turbulent times. And they do not operate within institutions that generate feedback to tell them whether their monetary policies are the correct ones.

There is no reason why monetary policy should not adhere to the rule of law. Rule-of-law monetary systems are more ethically justifiable. They also work better. Whether the preferred alternative is a gold standard, an unbreakable and automatic rule for the money supply, or even a system based on Bitcoin, contemporary monetary institutions must be changed such that they meet the requirements of the rule of law. Post-Enlightenment jurisprudence has informed virtually all modern governance systems. Monetary systems should be informed by it as well.

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Alexander W. Salter

Alexander W. Salter is an Assistant Professor of Economics in the Rawls College of Business and the Comparative Economics Research Fellow with the Free Market Institute at Texas Tech University. His research interests include the political economy of central banking, NGDP targeting, and free (laissez-faire) banking. He has published articles in leading scholarly journals, including the Journal of Money, Credit and Banking, Journal of Economic Dynamics and Control, Journal of Financial Services Research, and Quarterly Review of Economics and Finance. His popular work have appeared in RealClearPolitics and U.S. News and World Report.

Salter earned his M.A. and Ph.D. in Economics at George Mason University and his B.A. in Economics at Occidental College. He was an AIER Summer Fellowship Program participant in 2011.