Business Administration 4440Q/R/S/T Study Guide - Foreign Exchange Market, Arbitrage, Money Supply
19 Apr 2014
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Questions: explain the mechanism which restores the balance-of-payments equilibrium when it is disturbed under the gold standard. Answer: the adjustment mechanism under the gold standard is referred to as the price-specie-flow mechanism expounded by david hume. Under the gold standard, a balance of payment disequilibrium will be corrected by a counter-flow of gold. Suppose that the us imports more from the uk than it exports to the latter. Under the classical gold standard gold is the only means to settle international payments. Since in our example the us owes money to the uk gold must flow from the u. s. to the uk. As a result, the us (uk) will experience a corresponding decrease (increase) in money supply. This means that the price level will tend to fall in the us and rise in the uk consequently, us products become more competitive in the export market, while uk products become less competitive.
