And most countries these days run their macroeconomic policies with either the internal or external price objective in mind. If it's the Bank of England or the European Central Bank, it's explicitly the internal objective, through the use of an inflation target. If it's the Federal Reserve, it's implicitly the internal objective: there's no specific inflation target but the control of inflation takes priority over the Federal Reserve's other objectives. No one quite knew how to control the money supply and, even if they did, any confidence to be had in a predictable relationship between money supply and, say, nominal GDP was swiftly undermined. The truth is that monetarism over-simplified the ways in which an economy operated and, by doing so, allowed its own credibility slowly to be diminished.Yet the legacy of monetarism is still with us. And so, for that matter, are the legacies of the Gold Standard and of Bretton Woods.
All three approaches attempt to stabilise some sort of nominal objective - either the domestic rate of inflation or, via the exchange rate, the external rate of inflation. Continental Europe preferred to construct a European version of Bretton Woods, with the Exchange Rate Mechanism being formed in 1979 following the earlier failure of the European Monetary Snake. Nevertheless, European countries eventually found themselves pursuing a "monetarism by proxy" policy via the Bundesbank, which emerged as the natural forerunner of the European Central Bank.Monetarism itself eventually proved to be a disappointment. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy."Of course, not everyone was seduced by monetarism - at least, not directly. As the late Lord Callaghan famously said in 1976: "We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending.
Countries didn't mind the occasional revaluation - that was a sign of virility - but they certainly didn't like the idea of a sudden devaluation Devaluation was an indignity. It indicated a lack of economic potency that doubtless brought back to leaders' minds their first few humiliating fumblings with the opposite sex when, even if the mind was willing, the body was limply less than able. As a result, currency adjustments didn't happen very often and countries simply protected their economic interests through the copious use of capital controls. Eventually, balance of payments disequilibria blew the system apart, leaving countries cast adrift without any kind of nominal anchor against inflation.And so monetarism was born. As Bretton Woods reached its natural, if somewhat painful, conclusion, policy makers were already searching for other options.
