The Gold Standard
Spring 2010: Open Economy Macroeconomics
Brittany Causey
How does a Gold
Standard work?
How does a Gold Standard
Work?

Each country fixes the price of its currency in terms
of gold by standing ready to trade domestic currency
for gold when necessary to defend the official price.

Each country is responsible for pegging its currency’s
price in terms of the official international reserve
asset, gold.

Results in fixed exchange rates between all
currencies.
Monetary Policy
Under a Gold
Standard
Monetary Policy Under a
Gold Standard: Example

Bank of England increases MS by purchasing domestic assets. Increase
in MS decreases Rpound making foreign assets more attractive.

Sell pounds to Bank of England for gold, then sell gold to other Central
Banks for their currencies. Use new currencies to buy deposits with
higher R than Rpound.

Bank of England loses reserves because it is forced to buy pounds and
sell gold to keep the pound price of gold fixed. Foreign Central Banks
gain reserves as they buy gold with their currencies

British MS decreases causing Rpound to increase and Foreign MS
increases causing R to decrease until R is equal across countries and
asset market is in equilibrium. Total world MS increases by amount of
Bank of England’s initial domestic asset purchase and R lower
throughout the world.
Monetary Policy Under a
Gold Standard: Summary

International monetary adjustment under a gold
standard is symmetric

Whenever one country is losing reserves and its
money supply is decreasing, foreign countries are
gaining reserves and seeing their money supplies
expand.
Benefits of the Gold
Standard
Benefits of the Gold
Standard

Money supply cannot grow more rapidly than real
money demand

Places automatic limits to increases in national price
levels through expansionary monetary policy
Drawbacks of the
Gold Standard
Drawbacks of the Gold
Standard

Undesirable constraints on use of monetary policy to
fight unemployment.

Tying currency values to gold ensures a stable overall
price level only if the relative price of gold and other
goods and services is stable.

Central Banks cannot increase their holding of
international reserves as their economies grow unless
there are continual new gold discoveries

Countries with potentially large gold production have
ability to influence world macroeconomic conditions
through market sales of gold.
The Bimetallic
Standard
The Bimetallic Standard

Currency based on both gold and silver

Could reduce the price level instability resulting from
use of just one metal as the standard.
The Gold Exchange
Standard
The Gold Exchange
Standard

Halfway between the gold standard and a pure
reserve currency standard

Central Bank’s reserves include gold and currency
whose price in terms of gold are fixed, and each
central bank fixes its EXRA to a currency with a
fixed gold price.

Restrains excessive money growth, but allows more
flexibility in growth of international reserves