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So I'm a total economics noob and I'm trying to understand some of the consequences of using vs. not using a gold standard listed on Brad DeLong's blog here: https://www.bradford-delong.com/why-not-the-gold-standard-talking-points-on-the-likely-consequences-of-re-establishment-of-a-gold-st.html. The first point DeLong mentions is that with a gold standard an economy somewhat loses it's ability to stimulate growth by increasing the money supply. He gives the following example:

...in the spring of 1995 the dollar weakened against the yen. Under a gold standard, such a decline in the dollar would not have been allowed: instead the Federal Reserve would have raised interest rates considerably in order to keep the value of the dollar fixed at its gold parity, and a recession would probably have followed.

It's been a while since I've taken Econ 101 so bear with me. I'm trying to work through this example with some simple test numbers to understand whats going on. Say that the U.S. is on the gold standard, and a \$1 bank note can be exchanged at any time for 1 unit of gold. In DeLong's example the dollar weakened against the yen, so let's say the exchange rate between dollar and yen was previously \$1/¥5, and now it's \$1/¥3.

I have a few, potentially silly questions. First, why does the change in exchange rate change the "gold parity" of the dollar? If a \$1 bank note still gets you one unit of gold (since the gold standard ensures it), won't you still be able to get one unit of gold, assuming you only have U.S. dollars? Maybe this assumption is where my confusion lies? My other thought was maybe that if the dollar weakens against the yen, people with yen will be able to get more gold, which may be problematic for the U.S's gold reserves, but how does increasing interest rates address this problem? As I recall, raising interest rates reduces the amount of money circulating in the economy. But again, \$1=1 unit of gold always, so how does this change things? Sorry if this is somewhat incoherent -- any help explaining DeLong's reasoning (ideally in very, very simple terms with not a lot of jargon) would be greatly appreciated. Thanks!

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  • $\begingroup$ Historically, “Gold Standard” covered a few regimes, so the question is somewhat vague. But it appears to me that the assumption is that the Japanese yen is also pegged to gold, so the exchange rate cannot move. As such, a lot of your question text is based on the wrong premise. It might be best to delete the parts that are based on the assumption of USD/JPY moving, since that confuses attempts to answer the qustion. $\endgroup$
    – Brian Romanchuk
    Apr 17, 2019 at 21:24
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    $\begingroup$ @BrianRomanchuk yeah, the specific gold standard doesn't matter much and doesn't need to be historically correct for my toy example: as long as money is pegged to gold somehow. When you say "the assumption is that the Japanese yen is also pegged to gold", what exactly do you mean? Isn't this implied by the fact that you could buy dollars with yen and gold with dollars? $\endgroup$
    – kjakeb
    Apr 17, 2019 at 21:53
  • $\begingroup$ @BrianRomanchuk Also, why would the yen also being pegged to gold (whatever that means) mean that the exchange rate can't move? Also, I'm having trouble figuring in your comment to DeLong's example. He said that the dollar weakened in comparison to the yen: is he saying that if the U.S. was on a gold standard, this weakening would occur but not for long because rising interest rates would correct it (and if so how), or would the weakening never occur in the first place? $\endgroup$
    – kjakeb
    Apr 17, 2019 at 21:56
  • $\begingroup$ @BrianRomanchuk ok, I think I see now how the exchange rate wouldn't be able to change if each currency was pegged to its own supply of gold. But my second question about how your answer fits into DeLong's framing of the situation is still bothering me. $\endgroup$
    – kjakeb
    Apr 17, 2019 at 22:32
  • $\begingroup$ I’ll try to answer... $\endgroup$
    – Brian Romanchuk
    Apr 17, 2019 at 22:42

1 Answer 1

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I would interpret the “Gold Standard” as being all (major) countries each pegging their currency to gold, or at least to a currency pegged to gold (e.g., the U.S. dollar in the Bretton Woods system). A single country pegging its currency to gold would make gold investors happy, but it would do very little otherwise, since the currency would just float like gold prices already do.

This means that the exchange rates cannot appreciably move (there is usually a small trading band around parities).

This is why that DeLong says that the decline “... would not be allowed.” That is, if tge currency was weakening within its small trading band, the central bank needs to defend the parity: typically raising interest rates. If that does not help, the government is forced to launch fiscal austerity, which shrinks the economy. This reduces imports, which will hopefully take the pressure off the exchange rate.

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  • $\begingroup$ You're explanation could also be used to explain the recessionary bias DeLong alludes to on the same page? $\endgroup$
    – An old man in the sea.
    Nov 18, 2020 at 0:24
  • $\begingroup$ Yes, because the way Gold Standards worked in practice, they forced countries with weak economies into austerity policies to narrow trade deficits. To relate to the original question, it assumed that the local currency was just pegged to gold, which has no international effects if all other currencies float versus gold. $\endgroup$
    – Brian Romanchuk
    Nov 18, 2020 at 2:35

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