Gold Standard

The gold standard was the predominant international monetary system between 1880 and 1914. Britain was the first country to adapt the gold standard in 1717. The United States switched to it in 1834, followed by a number of European countries during the 1870s.

The countries joining the gold standard agreed to fix the price of their currency in terms of gold, thus adapting a fixed exchange rate regime. The country’s money could be converted into gold any time at this exchange rate. Joining the classical gold standard meant giving up the possibility of independent monetary policy. If a country on the classical gold standard experienced a balance of payment surplus, the central bank had no choice, it had to increase interest rates to facilitate a gold inflow. Few countries followed completely the rules of the gold standard in practice. Some countries, like France, limited the convertibility of the national money into gold, in order to maintain independent monetary policy.

The gold standard aimed to keep prices stable by regulating the quantity of the money supply. Still, prices were not completely stable under the gold standard. Deflationary pressure developed as the world economy and the supply of real commodities grew, but the supply of money could not increase because of the limited quantities of gold available. Other times it was impossible to avoid inflation, when new gold supplies were discovered, the price level had to adjust. By fixing the exchange rate of gold and various national currencies, the prices all around the world moved together.

References:

Eichengreen, Barry J., and Marc Flandreau. “Introduction.” In The Gold Standard in Theory and History, edited by Barry J. Eichengreen and Marc Flandreau, 1-30. London: Routledge, 1997

The Concise Encyclopedia of Economics http://www.econlib.org/library/Enc/GoldStandard.html 10/12/2010