Question

Describe the concept of an "automatic adjustment mechanism" pertaining to international finance and trade. Give 1 specific example of automatic adjustment mechanism as it works in international finance and trade.

Answer 1

The two pillars of the classical approach to international trade are the automatic adjustment mechanism and the commodity trade operated by the law of comparative advantage. The automatic adjustment mechanism is from Hume’s story on specie-flow mechanism.

The automatic adjustment mechanism is for correcting the balance of payment disequilibria under the gold standard. Under the gold standard, the supply of money consists of both gold or paper backed by gold. The supply of money fall in the deficit nation and rise in the surplus nation. So the domestic prices fall in the deficit nation and grow in the surplus nation. It leads the exports of deficit nation increased, and imports would be discouraged to the balance of payment disequilibria eliminated.