Daniel Smith and Alexander Salter on *Money and the Rule of Law: Generality and Predictability in Monetary Institutions*

Episode Summary

Executive Summary: In this live Macro Musings episode, David Beckworth interviews Dan Smith and Alex Salter about their book arguing that monetary policy should be governed by a true binding rule rather than discretionary central banking. They link rule-based money to the rule of law, discuss the Fed’s role in the Great Recession, explain knowledge and incentive problems in central banking, and outline why public accountability and predictable nominal anchors matter.

Main Topics: Money, the Rule of Law, and Democratic Legitimacy (Priority: 5/5): The guests argue monetary institutions should be general, predictable, and non-discriminatory, treating money as a citizen property right rather than a central bank prerogative. Why Monetary Policy Needs Binding Rules (Priority: 5/5): They distinguish real rules from pseudo-rules, insisting that discretion and unenforced targets fail to constrain central banks or anchor expectations. The Fed, the Great Recession, and Policy Mistakes (Priority: 5/5): The conversation revisits the housing boom and post-2008 response, arguing the Fed was too loose before the crisis and too tight afterward via IOER and weak nominal spending support. Knowledge Problems in Monetary Policy (Priority: 5/5): They separate technical complexities from deeper knowledge limits, arguing central bankers cannot reliably know objectives, targets, instruments, or real-time money demand. Incentives, Bureaucracy, and Political Pressure (Priority: 4/5): The guests say central bankers face internal bureaucracy problems and external pressures from debt accommodation, politicians, and special interests, which weaken independence. Alternatives: Free Banking, Crypto, and Institutional Reform (Priority: 4/5): They discuss free banking history, cryptocurrencies, and possible reforms, while emphasizing that politically feasible changes are more likely than abolition of the Fed. Average Inflation Targeting and the Fed’s New Framework (Priority: 3/5): They view average inflation targeting as a partial improvement over simple 2% inflation targeting, but not a substitute for a true monetary rule.

Key Arguments: A binding monetary rule is needed to make policy both macroeconomically effective and democratically justifiable. The Fed contributed to the Great Recession both by being too loose before the crisis and too tight afterward, especially through IOER that kept liquidity from circulating. Central banking suffers from knowledge problems because policymakers cannot know objectives, targets, instruments, or the economy’s true state well enough in real time. Even better data, AI, or digital currencies would not eliminate the knowledge problem because economic conditions and private behavior change simultaneously. Central bankers face bureaucracy-like incentives: inertia, self-preservation, groupthink, and research ecosystem bias through employment and sponsorship of monetary economists. External pressures from government debt, elected officials, and financial interests make discretionary central banking vulnerable to politicization and capture. The rule of law in monetary policy means rules should be general, predictable, and non-discriminatory, with meaningful enforcement for violations. Pseudo-rules like the Fed’s old 2% target are weak because they lacked binding penalties and were repeatedly missed without consequences. Free banking and commodity-standard-style systems historically showed that money and banking can function with less central discretion than modern policy allows. Average inflation targeting may improve credibility somewhat, but it does not solve the deeper institutional problems of discretion and weak enforcement.

Data Points: Book title: Money and the Rule of Law, Generality and Predictability in Monetary Institutions - The new book discussed in the live podcast Bernanke speech date: November 8, 2002 - Bernanke’s Friedman conference speech quoted as historical motivation Fed inflation target: 2% - The Fed’s voluntarily chosen inflation target discussed as a pseudo-rule Great Recession period policy critique: April to October 2008 - Beckworth referenced the Fed keeping rates around 2% during the period IOER policy: Interest on excess reserves - Described as a policy that kept post-crisis liquidity from circulating FOMC/average inflation target discussion: Average inflation targeting - The Fed’s newer framework discussed as an improvement over simple annual inflation targeting Number of mandate goals: 3 - The guests noted the Federal Reserve Act is effectively a triple mandate, including moderate long-term interest rates Great Depression comparison: 70 years - It took about 70 years for Bernanke to publicly acknowledge the Fed’s Great Depression failure Canada central bank founding: 1935 - Mentioned in the free banking discussion as the year the Bank of Canada was created US bank closures in the Great Depression: 9,000 - Cited to contrast the U.S. experience with Canada’s more stable banking system Federal Reserve floor system shift: Permanent adoption after the crisis - Discussed as an example of central bank inertia New Zealand-style discipline: Removal for failure to meet mandate - Mentioned as a possible accountability mechanism for central bankers

Pivotal Quotes: "if we want monetary policy to be macroeconomically effective and democratically justifiable, you need to have a strict monetary rule in place" — Dan Smith: Opening executive summary of the book’s thesis "we think that money should be treated as a property right of citizens, not a prerogative of central bankers" — Dan Smith: Explanation of the book’s normative framework "A policy rule to stabilize something like nominal expenditures would have solved that problem" — Alex Salter: Discussion of the Fed’s post-2008 response and the case for rules

Implications: The discussion favors rule-based, accountable monetary institutions over discretionary central banking. For listeners, the takeaway is that legitimacy, predictability, and crisis performance depend on binding constraints, not expert judgment alone.