16 open economy
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Chapter 16
Open-Economy
Macroeconomics and theInternational MonetarySystem
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Adjustment Under the
Gold Standard
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Adjustment Under the
Gold Standard The Gold Standard Operated rom a!out 1"#$ tothe out!rea% o &orld &ar I in 1'1()
An attempt *as made to reesta!lish the +old
standard ater the *ar, !ut it ailed in 1'1durin+ the Great .epression)
Under the +old standard, each nation de/nes the+old content o its currency and passi0ely stands
ready to !uy or sell any amount o +old at thatprice)
Since the +old content in one unit o eachcurrency is /ed rates are also /ed)
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Mint parity
2or eample, under the +old standard, a 1pound +old coin in the United 3in+domcontained 11)$$16 +rains o pure +old,
*hile a 41 +old coin in the United Statescontained 5)55 +rains)
This implied that the dollar price o the
pound, or the echan+e rate, *as 748pound 7 11)$$1685)55 7 ()"#)
This is called mint parity)
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The 9rice-Specie-2lo*
Mechanism The automatic adjustment mechanismunder the +old standard is the price-specie-:o* mechanism)
This operates as ollo*s to correct!alance-o-payments dise;uili!ria)
Since each nation<s money supply under
the +old standard consisted o either +olditsel or paper currency !ac%ed !y +old,the money supply *ould all in the de/citnation and rise in the surplus nation)
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The 9rice-Specie-2lo*
MechanismAs a result, the eports o the de/citnation *ould !e encoura+ed and its
imports *ould !e discoura+ed until thede/cit in its !alance o payments *aseliminated)
The reduction o internal prices in the
de/cit nation as a result o the +old lossand reduction o its money supply *as!ased on the ;uantity theory o money)
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The 9rice-Specie-2lo*
Mechanism.a0id =ume introduced the price-specie-:o* mechanism in 1#>5 and used it todemonstrate the utility o the
mercantilisits< !elie that a nation couldcontinuously accumulate +old !yeportin+ more than it imported)
=ume pointed out that as a nation
accumulated +old, domestic prices *ouldrise until the nation<s eport surplus?*hich led to the accumulation o +old inthe /rst place@ *as eliminated)
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The 9rice-Specie-2lo*
Mechanism The eample =ume used ma%e this pointis surpassed
That is, it is utile to attempt to raise the*ater le0el ?the amount o +old@ a!o0eits natural le0el in some compartment?nation@ as lon+ as the compartments
are connected *ith one another ?i)e) aslon+ as nations are connected throu+hinternational trade@
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The 9rice-Specie-2lo*
Mechanism9assi0ely allo*in+ the nation<s moneysupply to chan+e or !alance-o-paymentsconsiderations meant that nations could
not use monetary policy or achie0in+ ullemployment *ithout in:ation)
Bet, this created no diculties or classical
economists, since ?as pointed out earlier@they !elie0ed that there *as an automatictendency in the economic system to*ardull employment *ithout in:ation)
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The 9rice-Specie-2lo*
Mechanism=o*e0er, that or adjustment process tooperate, nations *ere not supposed tosteriliDe ?i)e) neutraliDe@ the eect on their
money supply o a de/cit or surplus intheir !alance o payments)
On the contrary, the rules o the +ame o
the +old standard re;uired a de/cit nationto reinorce the adjustment process !yurther restrictin+ credit and a surplusnation to epand credit urther)