Problem 18 Explain how a gold standard, as ... [FREE SOLUTION]

Chapter 15: Problem 18

Explain how a gold standard, as monetary policy, would work.

Short Answer

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The gold standard is a monetary system where a country's currency or paper money has a value directly linked to gold. Governments that use the gold standard can only print as much money as their gold reserves. Under the gold standard system, gold and economy are directly linked, establishing financial stability. This is because the gold supply across the world grows only slowly and can鈥檛 be rapidly increased.

Step by step solution

Understanding the Gold Standard

The gold standard refers to a monetary policy where a country's currency or paper money has a value directly linked to gold. Under the gold standard, countries agreed to convert paper money into a fixed amount of gold. A country that uses the gold standard sets a fixed price for gold and buys and sells gold at that price. That fixed price is used to determine the value of the currency. For example, if the U.S. sets the price of gold at $500 an ounce, the value of the dollar would be 1/500th of an ounce of gold.

Gold Standard and Economy

The gold standard is not currently used by any government. It was replaced by fiat money - a term to describe currency that is used because of a government's order, or fiat, that the currency must be accepted as a means of payment. Under the gold standard, the economy's money supply is tied to the supply of gold. To increase the money supply, a country would have to obtain more gold, which could mean mining more or buying more from other countries.

Procedure of the Gold Standard

In a gold standard system, gold is directly linked to the economy's money supply. The government can only print as much money as its country has in gold. To print more money, the government needs to purchase more gold. Therefore, the monetary policy under the gold standard is often associated with stability, since the world's gold supply grows only slowly and cannot be increased rapidly through any artificial means.