Pentti Pikkarainen
July 28, 2020

Reflections of a Monetarist Hawk on Monetary Arrangements and Gold

Pentti Pikkarainen, Former Bank of Finland Head of Department wrote his thoughts on monetary arrangements and gold.

I have worked as an economist in several positions at a central bank, ministry of finance and universities. Monetary arrangements have always been on my focus either as a policy practitioner or as a researcher.

While working at the Bank of Finland some of my colleagues called me a monetarist hawk or a hard line monetarist. I do not like naming and shaming but that description reflects quite well my thinking on monetary issues.

I am an old school monetarist in the sense that one should pay attention to the development of monetary aggregates and credit expansion. If monetary expansion is very fast – clearly faster than growth of potential output – for a long time, it indicates that the economy is moving towards an unbalanced situation. Typically asset prices (in house, stock, bond markets) are booming and bubbles are created. When bubbles burst, the economy faces problems and ordinary people suffer.

I am a hawk in the sense that I know how hard it is to tighten monetary policy and conduct sound fiscal policy. It is easy and popular to cut interest rates but you are not applauded when you tighten monetary policy. Monetary policy tightening is necessary in some situations to keep the real economy and monetary economy on a balanced path. Those who support only loose monetary conditions are creating dangerous bubbles.

Occasionally you can identify unsustainable monetary arrangements. A country may choose an exchange rate regime that is not appropriate. For instance, if a country is not able to live with the strict requirements of a fixed exchange rate regime, in the end the arrangement will collapse. In Finland the fixed exchange rate regime collapsed in 1992. The same is true with a single member in a monetary union or the whole monetary union. If there are no permanent fiscal transfers to weak members, they may leave the union.

I am no fan of cryptocurrencies. I consider cryptocurrencies as scams. You may make a lot of money by speculating in cryptocurrencies but you need to understand that cryptocurrencies are backed by nothing. I stay far a way from cryptocurrencies.

Since the start of the global financial crisis in 2008 and the euro area crisis in 2010, (major) central banks have injected huge amount of liquidity to financial markets. They have continued the policy during the covid-19 crisis.

Expansionary monetary and fiscal policies are justified in this type of situations. However, there is a risk of overshooting of expansionary policies. Everything we observe is not necessarily healthy and sustainable.

How is this related to gold?

I was not very happy when the USA abolished the relationship with gold and the US dollar in the Bretton Woods system. The arrangement imposed discipline to the international monetary system.

I think that discipline has partly disappeared in current monetary arrangements. The extreme cases are Venezuela and Zimbabwe. Hyperinflations in Venezuela and Zimbabwe have caused huge damage and hurt their people. One should not encourage central banks to follow these examples.

One approach to protect oneself from the consequences of irresponsible and unsustainable economic policies and monetary arrangements is to hold gold as a part of portfolio. This has been demonstrated in many studies. In extreme conditions it may be the only approach and protection. The US dollar and gold typically replace the local currency in hyperinflations. I also think that central banks should hold more gold in their reserves. This is an indicator that a central bank is responsible and “serious” and has something real in its balance sheet.

Pentti Pikkarainen is an expert in economics and finance. He has an extensive background from the Bank of Finland, and the Ministry of Finance. He has also been actively involved in EU cooperation in Frankfurt and Brussels, as well as in Nordic Investment Bank NIB, Sitra and the State Treasury.

Pentti Pikkarainen completed his PhD in economics at the University of California, Los Angeles (UCLA). His current interests include international monetary economics, financial markets, economic growth, public administration, and political decision-making. In addition to scientific publications, Pikkarainen has written articles, columns and blogs on economic policy.

At Voima, Mr. Pikkarainen holds a position as an advisor and provides monetary and economic insight to Voima’s business development and business strategy decision making.

Pentti Pikkarainen

Pentti Pikkarainen

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