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Econ1530final - John Alexander Wallin J Question#1 Econ...

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John Alexander Wallin Econ 1530 Final July 29, 2010 Question #1 This transaction set is between the US and the Country “Europa” (a fictionary country with the currency €) (Table 1.B). The system is the International Gold Standard. The transactions in this example are considered large enough to influence the exchange rate. For identification of key items see Table 1.A. 1) Joe Gold-digger found a good amount of gold in his cave and deposited it at his local bank (Bank of California) for XX amount of $ in his bank account. 2) Bank of California already have enough gold in their vault so they ship it to the Central bank for cash. 3) The treasury notices that the US Central bank has an increased amount of gold and they feel like they could boost the economy a little by taking a loan from the central bank. 4) Joe Gold-digger fells like he could expand his business as the economy is boosting, so he takes a loan from the local bank to buy some digging equipment. 5) Joe realizes that the shovels would be much cheaper if he bought it in Europa, so he buy’s it from Jimmy Europe (a citizen of Europa) for XX amount of $. 6) Jimmy Europe exchange his $ for a deposit of XX € at his local bank (Bank of Europa). 7) Bank of Europa knows that it can exchange $ for a certain amount of gold in the US so they call their buddies at Bank of California and exchanges their $ for gold at a fixed price.
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John Alexander Wallin Econ 1530 Final July 29, 2010 8) Bank of Europa exchanges the gold for XX amount of € with Europa’s Central bank. 9) Bank of California, who sold their gold to Europa get in to a Short-run liquidity crisis and needs to lend money from the Central bank according to the Bagehot’s rule. 10) The min parity in the country can no longer hold as the Central Bank cannot exchange gold for the same fixed rate and it becomes necessary to deflate the US economy. As seen from this set of transactions (Table 1.B) the international gold standard uses gold as a foreign exchange regulator. As the shovels were cheaper to purchase from Europa the gold streamed out of the US and in to Europa. Finally, the US had to deflate their economy to arrive at the same prices in shovels. The International Gold Standard in this transaction set, had limits, even though vaguer than the Bretton Woods system, to which entities carried the right to redeem the currency for gold as it was Bank of Europa and not Jimmy Europe. In the Bretton Wood System, this was called the special drawing rights. There are several differences between the International Gold Standard and the Bretton Woods system. As seen from the transaction set, there is no international capital control and there is no International Monetary fund to borrow from to cover the trade deficit. However there was one difference between the international gold standard and the Bretton woods system, which did not impact the US other than increasing its trading power, the implementation of a pegged rate system. As the pegged rate system was following the dollar which in itself was anchored to the gold. This means that the
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