Working Paper: CEPR ID: DP125
Authors: Willem H. Buiter
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.
Keywords: gold standard; domestic credit expansion; public debt; monetary policy; fiscal policy; Wiener process; random walk; open versus closed loop policy rules
JEL Codes: 300; 421; 431
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| flexibility of domestic credit expansion policies (E58) | viability of the gold standard (N13) |
| money demand shocks (E41) | collapse of the gold standard (N14) |
| insufficient responsiveness of domestic credit expansion (E51) | collapse of the gold standard (N14) |
| excess of domestic credit expansion over money demand (E51) | behavior of shadow floating exchange rate (F31) |
| shadow exchange rate reaches certain thresholds (F31) | collapse of the gold standard (N14) |
| global stock of reserves increases (Q35) | expected duration of the gold standard's viability (N13) |
| fixed, non-responsive rules (E61) | collapse of the gold standard (N14) |