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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 2 of 26
The real wordsTheory

How the gold standard worked

The period is 1880 to 1914. The deck states the mechanics in one sentence.

Each nation defined the gold content of its currency and passively stood ready to buy or sell any amount of gold at that price.

Mint paritythe exchange rate implied by the ratio of the two currencies' gold contents.

The rate could move slightly around mint parity, by the cost of shipping gold, and no further. The reason is arbitrage, and the next two screens do the numbers.

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