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Sem 5 Prep
← Open Economy MacroThe gold standard and the interwar years

Formulas for this chapter

Mint parity

R = gold content of currency being priced / gold content of currency priced in Section B's figures: 113.0016 / 23.22 = $4.87 per pound

Any gold standard question. The currency being priced always goes on top; check the direction by asking which coin holds more metal.

113.0016 grains
Gold content of the pound gold coin
23.22 grains
Gold content of the dollar gold coin

The gold points

Gold import point = mint parity - shipping cost Gold export point = mint parity + shipping cost Band width in % = 2 x shipping cost in % Section B's figures: $4.84 and $4.90 around $4.87, a 1.23 % band

Whenever a question gives a shipping cost, in cents or as a percentage. Compute the points, then any arbitrage profit is the distance beyond the relevant point.

shipping cost
About 3 cents per pound's worth, New York to London. Express it in the same units as parity before adding
arbitrage saving
(market rate - gold export point) x amount, when the rate is above the ceiling

Quantity theory, the engine of the price-specie-flow mechanism

M V = P Q With V and Q constant: % change in P = % change in M Gold flow = the size of the balance of payments imbalance

Converting a gold loss into a price fall, which is the middle step of Hume's mechanism.

M
Money supply, which falls with a gold outflow
V
Velocity of circulation, assumed constant
P
General price index
Q
Physical output, assumed constant

Overvaluation at a restored parity

relative price level = home price index / partner price index (a RATIO, not a difference) competitive parity = old parity / relative price level overvaluation % = (old parity - competitive parity) / competitive parity deflation needed % = 1 - (partner index / home index)

The 1925 sterling question, and any question about a fixed rate set at the wrong level.

relative price level
Example: 155/124 = 1.25, so 25 % dearer, not 55 - 24 = 31 %
deflation needed
Example: 1 - 124/155 = 20 %, smaller than the 25 % overvaluation because the base differs
Step 1 of 26
The ideaTheory

Two coins on a scale

Suppose a pound coin contains five grams of gold and a dollar coin one gram. Then a pound is worth five dollars, and no committee decided that: the metal did.

Fix each currency to a weight of gold and you have fixed every exchange rate between them, automatically.

That is the whole idea of the gold standard. What made it interesting was not the arithmetic but the discipline: to hold the link, a country losing gold had to let its economy shrink. This chapter is that arithmetic, that discipline, and what happened when nations stopped accepting it.

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