DP125 | A Gold Standard Isn't Viable Unless Supported by Sufficiently Flexible Monetary and Fiscal Policy

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01/08/1986

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Abstract

The paper studies an idealized gold standard in a two-country setting. Unless national policies for domestic credit expansion (dce) are flexible enough to offset the effect of money demand shocks on international gold reserves, the gold standard collapses with certainty in finite time through a speculative selling attack against one of the currencies. Various policies for postponing a collapse are considered. When a dce policy is sufficiently responsive and eliminates the danger of a run on a country's reserves, the exogenous shocks disturbing the system, which previously were reflected in reserve flows, now show up in the behaviour of the public debt. Unless the primary (non-interest) government deficit is permitted to respond to these shocks, the public debt is likely to rise (or fall) to unsustainable levels. The idealized gold standard analysed in this paper is only viable through the active and flexible use of monetary and fiscal policy.