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)