Apply AD-AS Model and Suitable Measure of External Balance to Explain What Happen To an Economy on the Gold Standard at an Overvalued Exchange Rate

Economy on the Gold Standard at an Overvalued Exchange Rate

AD-AS Model

The AD-AS or Aggregate Demand-Aggregate Supply form is a macroeconomic form that interprets cost grade and yield through the connection of aggregate demand and aggregate supply. John Maynard Keynes introduced it in his work The General Theory of Employment Interest, and Money. It is the base for the up to date area of macroeconomics (Krishna Dutt & Skott, 1996)), and is acknowledged by a very broad range of economists, from Libertarian, Monetarist supporters of laissez-faire, for example Milton Friedman to Socialist, Post-Keynesian supporters of financial interventionism, for example Joan Robinson. This paper explains what happen to an economy on the gold standard at an overvalued exchange rate by applying AD-AS model and suitable measure of external balance.

Gold Standard

Gold is a yellowish, soft, transition metal with the atomic number of 79 and an elemental symbol of Au. Gold has had enormous social and economic significance worldwide. Gold has been the standard for many currencies. The majority of the world's gold comes from South Africa, while two-thirds of gold consumed in the United States comes from Nevada and South Dakota.

Exchange Rate

The exchange rate represents the price at which one currency can be bought by another. Currency trading takes place on auction markets, known as foreign exchange markets, where annual turnover now exceeds global domestic product (GDP) by a factor in excess of forty. The exchange-rate regime refers to the public management of exchange rate relations, and thus shapes the context for trading on the foreign exchange market. The prevailing exchange-rate regime is determined by the decisions of governments, usually acting collectively under the auspices of an international agreement. On certain occasions, however, economically powerful countries have been able to reconfigure the exchange-rate regime while acting unilaterally.

The academic literature tends to focus on the difference between two types of exchange-rate regime: fixed versus floating. A fixed regime locks in the relative value of domestic currencies, hence determining the price at which they are exchanged. The classical gold standard, in operation in its purest form between 1870 and 1914, provided the basis for one fixed exchange-rate regime. Each currency had a set price in relation to gold and, because gold acted as a common denominator, each currency also had a ...