Price Specie Flow Mechanism

4 Key excerpts on "Price Specie Flow Mechanism"

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  Theory And Empirics Of Exchange Rates, The

  • Imad A Moosa, Razzaque H Bhatti(Authors)
  • 2009(Publication Date)
  • World Scientific

    (Publisher)

  CHAPTER 4 The Theory of the Balance of Payments 4.1. The Price-Specie Flow Mechanism Prior to the 1930s, there were no comprehensive theories of the balance of payments, devaluation, and balance of payments policy (Johnson, 1977, p. 218). The price-specie flow mechanism of Hume (1752) was, however, viewed as one of the earliest approaches to the balance of payments. While this mechanism is recognized to be the historical origin of the monetary approach to the balance of payments, Johnson (1977) regarded it as no more than a well worked out theory of the mechanism of international adjustment under the gold standard. 1 Johnson (1972a, p. 1555) argues that Hume was concerned about refuting the mercantilists’ policy of accumulating precious metals within a country and their consequent recommendation of policies designed to bring about a surplus in the balance of payments. Hume (1752) used the price-specie flow mechanism to demonstrate the impossibility of the mercantilist goal of maintaining permanently balance of payments surplus and a corresponding persistent specie inflow. He noted that the additional specie would (by raising domestic prices relative to foreign prices and so discouraging exports and spurring imports) result in a balance of payments deficit and eventually a reversal of the specie flow. Based on the quantity theory of money, it was demonstrated that the mercantilist fear of the scarcity of money was unwarranted as any quantity of money, via a proportional adjustment in prices, could drive the trade of a country. Thus, the price-specie flow mechanism, which is per se a corollary of the quantity theory of money, demonstrates that a surplus in a country’s balance of payments causes relative prices to rise via a consequent expansion in the money supply, which in turn establishes equilibrium in the balance of payments by reducing exports and raising imports. 1 See Johnson (1972a) and Frenkel and Johnson (1976). 104

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  Introduction to International Economics

  • Dominick Salvatore(Author)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  The automatic adjustment mechanism under the gold standard was the price-specie-flow mechanism. This operated as follows to correct Price-specie-flow mechanism The automatic adjustment mechanism under the gold standard. It operates by the deficit nation losing gold and experiencing a reduction in its money supply. This in turn reduces domestic prices, which stimulates the nation’s exports and discourages its imports until the deficit is eliminated. A surplus is corrected by the opposite process. a trade disequilibrium. Since each nation’s money supply under the gold standard consisted of either gold itself or paper currency backed by gold, the money supply would fall in the deficit nation and rise in the surplus nation. This caused internal prices to fall in the deficit nation and rise in the surplus nation. As a result, the exports of the deficit nation would be encouraged and its imports would be discouraged until the deficit in its balance of payments was eliminated. The reduction in the deficit nation’s money supply would also increase interest rates in the nation, which induced a financial inflow that helped the nation finance its deficit. The opposite occurred in the surplus Chapter Thirteen Automatic Adjustments with Flexible and Fixed Exchange Rates 333 nation (a more detailed description of the operation of the gold standard is given in Appendix A13.1). The adjustment mechanism under a fixed exchange rate system not tied to gold operates in a similar way, except that nations set exchange rates (par values) at what they believe to be the equilibrium level and the deficit nation finances or covers a trade or balance-of-payments deficit with its international currency reserves instead of gold. A deficit here also reduces the nation’s money supply, which tends to reduce prices relative to the surplus nation (which experiences an inflow of international currency reserves and rising money supply and prices), until the trade disequilibrium is completely corrected.

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  Studies in the Theory of International Trade

  • Jacob Viner(Author)
  • 2016(Publication Date)
  • Taylor & Francis

    (Publisher)

  3

  This reasoning seems erroneous to me. The conclusion of these writers results from a mechanical application of the formula of price determination to the international trade mechanism, on the implicit assumptions that the price level is result and not cause, and that the changes in M and the changes in T are unrelated and independent factors in the mechanism,4 and Feis, at least, explicitly attributes the same assumptions to the classical school.5 But in the classical theory, as in the preceding exposition, the establishment of international equilibrium is regarded as primarily a problem of international adjustment of prices, and the direction and extent of flow of specie, and therefore also the relative amounts of money in the two countries, instead of being treated as independent factors, are held to be determined by the relative requirements for money of the two countries given their equilibrium price levels and their respective physical volumes of transactions requiring mediation through money. The bearing of the commodity flows in the mechanism, therefore, is not their influence on the relative price levels, but is, instead, their influence on the quantity of specie flow necessary to support the price relations required for equilibrium.

  Let us suppose that when the lending first begins the lending country ships sufficient commodities on consignment to the borrowing country to bring its export surplus to equality with its volume of lending per unit period, but that, in consequence of the influx of goods, prices as a whole fall in the borrowing country to a level lower than is consistent with the maintenance of its import surplus at the required amount. A new or intensified flow of specie must thereupon occur from lending to borrowing country, so as to bring prices (and demands) in the borrowing country to a level adequately high to result in a continuing import surplus equal to the borrowings.6

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  The Golden Age of the Quantity Theory

  • David E.W. Laidler(Author)
  • 2014(Publication Date)
  • Princeton University Press

    (Publisher)

  They were referring, to put it in terms of Fisher's equation of exchange (which is discussed in Chapter 3), to the interaction of a flow of money expenditure (MV) and a flow of goods offered for sale - T rather than Y - and arguing that prices (P) had to move in order to reconcile these two largely independently determined flows. Mill puts the matter in the following way: As the whole of the goods in the market compose the demand for TRANSMISSION MECHANISM 17 money, so the whole of the money constitutes the demand for goods. The money and the goods are seeking each other for the purpose of being exchanged. They are reciprocally supply and demand to one another (1871, pages 509-10). To think about price level determination in this way had a number of consequences for classical monetary economics. To begin with, and as we have already seen, exponents of the classical quantity theory were much more willing than their modern successors to entertain the possibility that changes in velocity might be autonomous sources of price level variations in their own right. Although from the early eighteenth century onwards, just about everyone who wrote about the quantity theory argued that a change in the quantity of money would lead to a proportionate change in prices, the argument was usually accompanied by the explicit qualification that this prediction depended upon the assumption of a constant velocity of circulation, and the warning that this assumption did not usually hold in the real world. Mill was far from alone in defining the quantity of money relevant to the quantity theory as notes and coin in active circulation, excluding 'hoards' of such assets from the relevant aggregate. We have also seen how keenly aware were he and his contemporaries of the presence of other assets in the circulating medium, and the role of 'credit' in determining prices.

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