Economic History Lecture 7

The Great Depression is an international phenomena, which was at the same time as a tight monetary policy, which also is an international phenomena. Why at the same time?

Gold standard

How did the Gold Standard work?

Monetary authority fixed gold price of the local unit of account (e.g. 1 USD = 1.505 grams of fine gold).  Domestic money is freely convertible into gold at this price. 2 countries on gold had a fixed exchange rate. Example: 1 GBP = 7.32238 grams of fine gold => 1 GBP = 4.87 USD.

Gold coverage ratio

Legal gold cover ratio typically between 25 and 40%

Actual gold cover ratio fluctuated around the legal ones:

lt = (pg * Gt)/base

lt = gold cover ratio

pg = officially fixed gold price (bijv. 0.6048g per Euro)

base = monetary base

Gt = quantity of monetary gold

How CBs fix Gold-cover ratio at equilibrium

CBs targeted cover ratio by setting interest rates for it.

Gold-cover ratio below target, then interest rates up (I up)

1) Gold inflows: Gt up

2) Lower money demand: Base down

So cover ratio increases.

Global gold supply fixed => gold-in and outflows offset each other.

The 2 rules of the game

The goal: Keep money supply proportional to gold reserve.

1)     Gold inflow countries had to expand their money supply proportionally (no sterilization)

2)     Gold outflow countries had to contract their Ms proportionally (accept deflation)

Global money supply stable; regional ups and downs.

Hume’s price-specie flow model

Trade surplus country: Exports more than it imports → gold flows in → money supply rises → prices go up → exports become more expensive → imports increase.

Trade deficit country: Imports more than it exports → gold flows out → money supply falls → prices drop → exports become cheaper → imports decrease.

Key idea: Gold flows adjust prices automatically, which tends to restore trade balance across countries. It’s essentially an automatic mechanism linking gold, money supply, and prices to correct international imbalances.