How Did the Gold Standard Really Work? A Comparison of the Price-Specie-Flow Mechanism and the Monetary Approach to the Balance of Payments
28 Pages Posted: 10 Mar 2021
Date Written: January 14, 2021
The price-specie-flow mechanism (PSFM) is a theory of the adjustment of the balance of trade and gold flows in response to deviations in relative price levels across countries under a gold standard. The PSFM is central to quantity-theoretic discussions of economic fluctuations under a gold standard as well as analysis of whether central banks followed "the rules of the game" of the gold standard. The PSFM is often the standard working assumption when it comes to gold standard adjustment. However, at least since Adam Smith there has been an alternative to the PSFM that has come to be known as the monetary approach to the balance of payments. The distinction between the PSFM and the monetary approach have important implications for both quantity-theoretic explanations of economic fluctuations as well as the interpretation of the so-called "rules of the game." In this paper, we outline and test the empirical predictions of each theory to determine which is more accurate. The evidence is mixed, but largely favors the monetary approach to the balance of payments.
Keywords: commodity money, gold standard, monetary approach to balance of payments, price-specie-flow mechanism
JEL Classification: B22, C52, E41
Suggested Citation: Suggested Citation