What is the traditional gold standard, how does it differ from the current monetary system, and how does it work to resolve trade imbalances?
What is the traditional gold standard, how does it differ from the current monetary system, and how does it work to resolve trade imbalances? Give an example. What are the advantages of being on a gold standard, and what are the drawbacks? What is the implication for exchange rates (or the exchange rate system), when two nations are on a gold standard?
The traditional or orthodox gold standard was a kind of monetary system in which a country’s currency value was fixed to a certain amount of the country’s gold reserves. The monetary system differed from the current monetary system in that whereas, in the former, the value of a currency was measurable to a specified gold amount. In the latter, the value of a currency is determined by its demand. The traditional gold standard works to correct trade imbalances by controlling imports and exports to prevent trade deficit. For instance, if a country was importing more than it was exporting, the country under the system had to trade the imports with gold, which would cause the government to reduce the amount of paper currency. Among the pros of engaging in the traditional gold standard was a reduction in risks in exchange rates. Risks linked to exchange rates were reduced since there lacked a fluctuation in the value of a currency as gold was the measure of currency. Secondly, was an observation of stringent monetary policies among nations concerned, and the ability to correct trade imbalances. In contrast, the most significant drawback for the system was trade inconvenience, as gold is a scarce commodity. The implication for the exchange rate when two nations are on the gold standard is that there will exist un fluctuating rates since under the gold standard, the exchange tool is not subjective to price shocks.