Question

During World War I, when the Gold Standard was still in effect, European countries used their gold stores to buy war materials from countries like the U.S., which remained neutral for the first three years of the war and maintained the “exchange rate” of gold at $20.67 per ounce. As a result, there was an influx of gold into the U.S. Explain why this contributed to high inflation during the war.

Answer 1

Gold standard does not allow central banks to change money supply as money supply is related to amount of gold. Similarly value of a currency in international markets is also related to gold availability.

As USA remained neutral in initial years and European countries depended on USA too supply essential goods. Huge gold amount flew towards USA. The U.S. economy boomed during the first part of the 1920s, hence it was called the Roaring Twenties. A manipulative consumer, investor and business confidence existed in USA economy. Stock markets were booming and USA producers believed that demand for goods will keep on increasing. Hence average price levels kept on going up.

People also hoarded gold and as Federal reserve had less choice in changing interest rates to fight inflation, it kept on spiralling.