Low inflation gives the Reserve Bank reason to pause

The key question is whether there is a better system than monetary policy based on discretionary (ad hoc) inflation targeting via the instrument of "official" cash rates in a myriad of individual countries, which is the current mainstream approach.

One should at least consider a modern version of the gold standard. In place of a standard based on gold, one could imagine a commodity standard including preset weightings of gold, silver, platinum, copper, aluminium and even uranium.

There would be a preset annual growth (say 5 per cent) of the overall commodity bundle produced by an agency such as the International Monetary Fund.

The IMF would be responsible for acquiring the commodity bundles on a more or less continuous basis and feeding it to central banks in proportions based on each nations' real GDP. This idea is not, of course, original but rather is closely related to Keynes' Bancor system. Bancor is the name of the supranational currency that John Maynard Keynes proposed in the years 1940-42 and which Britain suggested after the Second World War. This supranational currency would, Keynes argued, be used in international trade as a unit of account within a multilateral barter clearing system.

The British proposal for a supranational currency could not prevail against the interests of the US, which at the Bretton Woods conference established the US dollar as the world's key currency.

Since the outbreak of the global financial crisis in 2007-08, Keynes' proposal is winning adherents. In a speech delivered in March 2009 entitled "Reform the International Monetary System", China's central bank governor, Zhou Xiaochuan, called Keynes' Bancor approach "farsighted" and proposed the adoption of IMF SDRs (special drawing rights) as a global reserve currency.

He argued that a national currency was unsuitable as a global reserve currency because of the difficulty faced by reserve currency issuers in trying to simultaneously achieve their domestic monetary policy goals and meet other countries' demand for reserve currency.

A similar analysis can be found in the UN's 2009 report, "Experts on reforms of the international monetary and financial system", as well as in a 2010 IMF publication, "Reserve accumulation and international monetary stability".

There are two essential differences between current arrangements and a Bancor system based on a bundle of commodities or SDRs.

Setting cash rates country by country, even by similar Taylor rules in pursuit of a common target for goods and services inflation, de-emphasises "quantity of money" targets. Setting and implementing a global "base money" target would de-emphasise interest rate targets. It is not at this time possible to decide which system might prove most robust, but clearly both need to be analysed carefully.

Along with rules for containment of bank lending, either a quantity focus or an effective interest rate focus is needed if capitalism is to minimise unhelpful financial system instability.

My more conservative friends will fear a global quantity-based monetary system would put too much power in one centralised agency.