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Chapter 30: Problem 4

An article in the Atlantic referred to a poll of economists that found no support for the United States to readopt the gold standard: It prevents the central bank from fighting recessions by outsourcing monetary policy decisions to how much gold we have -which, in turn, depends on our trade balance and on how much of the shiny rock we can dig up. When we peg the dollar to gold we have to raise interest rates when gold is scarce, regardless of the state of the economy. Why does the writer state that a gold standard would prevent "the central bank from fighting recessions"?

Short Answer

Expert verified
The gold standard would prevent the central bank from fighting recessions because it limits the central bank's ability to modify the monetary policy according to economic needs. Instead, it makes it dependent on the amount of gold reserve the country has, forcing to raise interest rates when gold is scarce, regardless of the economic conditions.

Step by step solution

01

Understanding The Gold Standard

The Gold Standard is a monetary system where the value of a country's currency or paper money has a direct correspondence to gold. In this system, a country's government can exchange their currency notes into a fixed amount of gold.
02

Gold Standard and Monetary Policy

In a gold standard system, the monetary policy decisions are tied to the amount of gold reserves a country has. This means that the central bank's ability to react to economic changes (like recessions) by adjusting monetary policy (changing interest rates or money supply) is limited.
03

Gold Standard, Interest Rates, and Economic Status

The scarcity or abundance of gold directly impacts the interest rates in a gold standard set-up. When gold is scarce, interest rates go up irrespective of the economic status of the country, making it harder for businesses and individuals to borrow and spend, which can worsen a recession. On the contrary, during an economic boom, abundant gold may lead to lower interest rates that can stimulate an overheated economy.
04

Summary of Writer's Statement

The writer opines that adopting the gold standard would prevent the central bank from fighting recessions. The reason is under the gold standard, monetary policy decisions, including adjustments to interest rates, depend on the nation's gold reserves, regardless of the current economic conditions. This limits the central bank's flexibility in responding to economic fluctuations, especially during recessions when proactive monetary policy is crucial.

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Most popular questions from this chapter

What does it mean when one currency is "pegged" against another currency? Why do countries peg their currencies? What problems can result from pegging?

What is an exchange rate system? What is the difference between a fixed exchange rate system and a managed float exchange rate system?

What were the main factors behind the globalization of capital markets in the 1980 s and 1990 s?

According to the theory of purchasing power parity, if the inflation rate in Australia is higher than the inflation rate in New Zealand, what should happen to the exchange rate between the Australian dollar and the New Zealand dollar? Briefly explain.

(Related to the Chapter Opener on page 1058 ) An article in the Wall Street Journal in June 2017 began with this observation: "The euro soared to its biggest one-day gain against the dollar in a year." Bayer AG sells Coppertone sunscreen in the United States. If Bayer produces Coppertone in the United States and sells it only in the United States, would an increase in the value of the euro against the dollar affect the company's profit from selling Coppertone? Briefly explain.
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