Gold, Dollars, Euro-Dollars, and the World Money Stock under Fixed Exchange Rates
Abstract
In a rapidly inflating domestic economy, explanation of the inflationary process must of necessity focus on the determinants of the money supply. By analogy, in a closely integrated economy under fixed exchange rates the behavior of the sum of individual countries' money stocks-the ,world money should play an important role in determining the behavior of the world price (an index of national price levels). This is recognized in analytical models of the international monetarist variety where, under the assumption that all goods are traded (or more generally that relative prices are not affected in the long run by monetary disturbances), the price level adjusts to equate the demand for money with the supply. Strictly fixed exchange rates imply that national money stocks can be treated as components of a Hicksian composite commodity, the money stock, since exchange-stabilization operations prevent variations in the relative values of national currencies. Closely integrated capital markets insure that the money stock is redistributed rapidly from country to country in response to payments disequilibria of monetary origin, thus ensuring a tendency towards rapid return to balance-of-payments equilibrium (which can, of course be frustrated by systematic attempts at neutralization of reserve flows). Closely integrated goods markets insure that the price levels of various countries move in harmony abstracting of course, from divergent trends in productivity and/or tastes that may cause changes in relative prices, including both the terms of trade and the ratio of the price of nontraded to traded goods. In such a world, one can view the stock of money as determining the price of a composite commodity, the components of which are national output levels. Though far too simple for many purposes, this Humean or Ricardian view of the economy is instructive in periods dominated by disturbances of monetary origin. For this type of analysis to be complete, however, the question of what determines the supply of money in the must be answered. This paper seeks to answer this question within the confines of a conceptually (though not necessarily algebraically) very simple model. The is assumed to be divided into two parts, Europe and the United States. money stocks consist of commercial bank liabilities only, and the money stock is defined as the sum of the money balances held by the public of each country.' Various institutional arrangements are considered, including a gold standard, a dollar standard, and the Euro-dollar system. The model provides a first answer to such questions as: does it make any difference to inflation whether monetary expansion originates in one region or the other; what asymmetries does a dollar standard introduce into the international monetary system; what determines the size of the Euro-dollar market and in what sense, if any, is its growth inflationary? Two key assumptions are used to answer these questions, namely, 1) that reserve * Professor of international economics, Graduate Institute of International Studies, Geneva, and visiting professor of economics, Harvard University. The original version of this paper was prepared for the Money Study Group's Oxford Seminar in honor of James Meade, September 25-27, 1974. It includes material developed in connection with a research project on National Economic Policy and the International Monetary System at the Graduate Institute of International Studies under a grant from the Ford Foundation. ITo sum national money stocks, they must of course be expressed in terms of the same currency, existing fixed exchange rates providing the required conversion factor.
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