Price-Level Determination Under the Gold Standard

48 Pages Posted: 1 Mar 2024

See all articles by Jesús Fernández-Villaverde

Jesús Fernández-Villaverde

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Daniel R. Sanches

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Date Written: February, 2024

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

Suggested Citation

Fernández-Villaverde, Jesús and Sanches, Daniel R., Price-Level Determination Under the Gold Standard (February, 2024). FRB of Philadelphia Working Paper No. 24-6, Available at SSRN: https://ssrn.com/abstract=4744246 or http://dx.doi.org/10.21799/frbp.wp.2024.06

Jesús Fernández-Villaverde (Contact Author)

University of Pennsylvania - Department of Economics ( email )

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Daniel R. Sanches

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

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