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GOLD STANDARD

The gold standard was an arrangement by interested nations to fix the prices of their domestic currencies to a certain quantity of gold. National money, as well as other forms of money (such as bank notes and deposits), was freely converted into gold at the predetermined price. England implemented a de facto gold standard in 1717 and formally implemented the gold standard in 1819. The period from 1880 to 1914 is regarded as the classical gold standard. Within that time, lot of nations adhered (in varied degrees) to gold. It was likewise a definite period of exceptional economic growth with considerably free trade in capital, labor, and commodities.

The main advantage of a gold standard is the fact that it guarantees a low level of inflation. As far as the supply of gold doesn’t change too rapidly, the supply of money remains quite stable.

The gold standard helps prevent a nation from printing a ridiculous amount of money. Once the supply of money soars rapidly, then individuals would probably convert money (having become less scarce) for gold (that has not). When this continues for a long time, then the government will ultimately run out of gold. A gold standard limits the Federal Reserve from enacting laws and regulations that substantially alter the increase in the supply of money which often limits the inflation rate of a nation.

The gold standard also changes the face of the currency market. The extensive utilization of gold standards indicates a system of fixed exchange quotes. Assuming every country is on a gold standard, there will be a single real currency, gold, from which others derive their value. The stability the gold standard creates in the FX markets is typically described as one of the benefits associated with the system.

On the flip side, the stability attributed to the gold standard can be the greatest downside of having one. Exchange rates are not in a position to react to varying conditions in countries. A gold standard extremely restricts the stabilization policies the Federal Reserve can implement. As a result of these issues, countries with gold standards are likely to have severe economic shocks.

At the same time, since the gold standard allows government minimal consideration to use financial policy, economies on the gold standard are not as much capable of avoiding or offset either real or monetary shocks. Actual output, as a result, is not constant under the gold standard. The coefficient of variation for actual production was 3 .5 between 1879 and 1913, and barely 1 .5 between 1946 and the year 1990. Not coincidentally, considering that the government cannot have discretion over financial policy, the unemployment rate was very high during the period of the gold standard. It averaged 6.8 percent in the US between 1879 and 1913 compared to 5.6% between 1946 and 1990.

Therefore, it may seem the substantial advantage to the gold standard is the fact that it can avert long-term inflation in a nation. But then, if you cannot rely on a central bank to keep inflation low, why would you trust it to continue running the gold standard for a long time? It does not seem like the gold standard could make a return to the States anytime in the distant future.

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