Working Paper

Price-Level Determination Under the Gold Standard

Abstract: We present a micro-founded monetary model of a small open economy to examine the behavior of money, prices, and output under the gold standard. In particular, we formally analyze Hume’s celebrated price-specie flow mechanism. Our framework incorporates the influence of international trade on the money supply in the Home country through gold flows. In the short run, a positive correlation exists between the quantity of money and the price level. Additionally, we demonstrate that money is non-neutral during the transition to the steady state, which has implications for welfare. 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. We discuss the importance of policy coordination for achieving efficiency under the gold standard and consider the role of fiat money in this environment. We also develop a version of the model with two large economies.

Keywords: Gold standard; specie flows; non-neutrality of money; long-run price stability; inelastic money supply;

JEL Classification: E42; E58; G21;

https://doi.org/10.21799/frbp.wp.2024.06

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2024-02-29

Number: 24-06