Switch to gold standard could stabilise prices – Philadelphia Fed research

Long-run price stability could be a key feature of the gold standard, researchers with the Federal Reserve Bank of Philadelphia find. 

In their working paper, published in February, Jesús Fernández-Villaverde and Daniel Sanches explore how the gold standard would operate as a monetary framework in a hypothetical small open economy economy. 

They argue that the price level would consistently converge to its long-run equilibrium value. Inflation and deflation would be “merely temporary phenomena”, they say. 

The gold standard was a monetary system used by many of the world’s leading economies throughout much of the 20th century. The value of a currency would be directly linked to the issuing country’s gold reserves. In many cases the gold standard proved too inflexible, and collapsed.

The authors argue that, during a transition to the gold standard, money would be non-neutral – that changes in the supply of and demand for money would impact the real economy in the long term. 

A permanent and unforeseen change in the adopting country’s economic integration with the rest of the world or a trade shock would be particularly dangerous in this framework, the authors find. Such a shock would cause temporary inflation or deflation in the domestic economy. 

“Because money is non-neutral, these price movements have real effects,” write the authors. “At least some home-country agents will be strictly worse off in the transition path.”

They nevertheless conclude that a gold-backed economy would be stable and self-correcting: “While the gold standard exposes the home country to short-term fluctuations in money, prices, and output caused by external shocks, it ensures long-term price stability as the quantity of money and prices only temporarily deviate from their steady-state levels.” 

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