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Timely Topics: The Gold Standard

Tuesday, November 4, 2014

The U.S. and many other economies left the gold standard more than 40 years ago, yet advocates periodically call for its return, saying that it would curtail or prevent inflation. In this Timely Topics from the St. Louis Fed video series, David Andolfatto, a vice president and economist with the St. Louis Fed, explains the gold standard and discusses its pros and cons.

Part 1: What Is a Gold Standard?

At one point, most of the world’s economies, including the U.S. economy, were under the gold standard. In the U.S. in the early 20th century, $20 in paper money was redeemable for an ounce of gold. The U.S. abandoned the gold standard in 1971.

Part 2: Gold Standard and Inflation

Under a strict gold standard, governments cannot print new money to finance expenditures, theoretically reducing the risk of high inflation caused by printing too much money. However, the government can still manipulate the purchasing power of a dollar under the gold standard by simply changing the amount of gold equal to $1.

Part 3: Purchasing Power

Most economists believe a return to the gold standard would not be a wise policy. With the supply of gold relatively fixed, changes in demand would cause its purchasing power to fluctuate on a short-term basis.

Part 4: Benefits of a Fiat Money System

Under the gold standard, banking panics are more likely to occur. The relatively fixed supply of money would not allow banks to satisfy demand if a large number of consumers tried to withdraw their money at the same time. Under a fiat money system, governments can create additional money and use it for short-term loans to satisfy additional demand. Once consumers see their money isn’t in danger, the potential panic subsides.

Part 5: The Gold Standard and the Central Bank

No economic system can completely protect against the threats posed by recessions, stock market bubbles, unemployment and inflation. However, the fiat system employed by the Federal Reserve has been largely successful in maintaining low inflation and price stability.

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