Question

Specie-Flow Mechanism

1.When Churchill returned England to the gold standard he did so at the old parity prior to World War One. This exchange rate made price levels (when converted into a common currency) instantly higher in England than elsewhere. Using the specie-flow mechanism model, show how this policy change could lead to a massive outflow of gold from England. Use the appropriate diagram in your answer.

Answer 1

As a result of Gold Standard prices in England became relatively very high compared to rest of the world than they otherwise would have been, this will encourage imports into England and discourage exports from England. Rest of the world will thus have high positive balances on current account and accumulate English currency along with its claim on gold. Thus foreigners will accumulate claims on gold leading to outflows of gold until such outflows lowered the value of England's currency in terms of gold, because less gold was availble to back it, and thus bought prices down to encourage more exports and discourage more imports.