In 1999, because of an op/ed opposing capital controls that I wrote in the Wall Street Journal in 1998, I was invited to give a paper on the subject to a small gathering in Tokyo. I don’t remember all the participants but two that I do remember were Jagdish Bhagwati and David Weinstein, both of Columbia University.

During one of the sessions, the Economic Freedom of the World index came up. Jagdish said that he didn’t think it was justified to list the inflation rate as a component of economic freedom because inflation had nothing to do with economic freedom. I had an answer to that but I wanted to follow the rules and so I never got to give my answer.

These are the four components of the sound money measure: (1) money growth, (2) standard deviation of inflation, (3) inflation in the most recent year, and (4) the ability to have foreign currency bank accounts. Notice that the first one is connected to inflation and the second and third are directly about inflation.

Here’s the answer that the authors of the report give in their latest report (p. 5):

Sound Money focuses on the importance of money and general price stability in the exchange process. Sound money—money with relatively stable pur- chasing power across time—reduces transaction costs and facilitates exchange, thereby promoting economic freedom. The four components of this area provide a measure of the extent to which people in different countries have access to sound money. In order to earn a high rating in Area 3, a country must follow policies and adopt institutions that lead to low (and stable) rates of inflation and avoid regulations that limit the ability to use alternative currencies.

That’s not a bad answer. The one I wanted to give Jagdish was a little different. It’s this. The point of the index, recall, is to measure economic freedom. But because we have a government-produced money, and virtually every other country does too, how do we measure economic freedom in the provision of money? The way to do so is to ask what we would have if the government stayed out of money and we had private provision of money. There are strong reasons to think that the inflation rate would be low and fairly steady. So that relates to (2) and (3). There are also strong reasons to think that money supply growth would be low, thus satisfying (1). Of course, the freedom to hold a bank account containing foreign currency is an obvious aspect of freedom, although that doesn’t directly relate to Jagdish’s objection.

Thus my justification for including money supply growth, variability of inflation, and the most recent inflation in the measure of economic freedom.

By the way, notice where the U.S. is on this measure: #31.

Note: The above pic is of Jagdish Bhagwati’s 1969 book, Trade, Tariffs and Growth. It was the main text of my Ph.D. course in international trade at UCLA in 1973-74. I learned more about international trade and tariffs from this book than from any other. It was taught by Robert E. B. Lucas, who is now a professor at Boston University. I thought Bhagwati should have co-won the Nobel Prize in economics with Paul Krugman in 2008. He didn’t. But come on guys, grow up and do the right thing. Jagdish is 89. It can’t be given posthumously. Give it to him this year.