Gold standard/Tutorials

The effect of gold stocks upon the money supply

(the following is a summary of a passage in Bernanke (2000) page 9)

Under the gold standard the effect of variations in a country's central bank stock of gold upon that country's money supply is governed by the identity:

M1 = (M1/BASE) x (BASE/RES) x (RES/GOLD) x PGOLD x QGOLD

where

M1 = money supply (money in circulation plus retail bank deposits);

BASE = monetary base (money in circulation plus retail bank reserves);

RES = international reserves of the central bank (foreign assets plus gold reserves);

GOLD =  gold reserves of the central bank, - PGOLD x QGOLD;

PGOLD = the price of gold per unit of quantity at which the central bank is required to buy and sell gold; and,

QGOLD = the size (quantity) of the central bank's gold reserve;

and

the ratio M1/BASE - the "money multiplier" is greater than 1 in a fractional reserve banking system (see the addendum to the article on banking);

the ratio BASE/RES is also greater than 1 where the central bank holds domestic assets as well as gold: and,

the ratio RES/GOLD is greater than 1 in a gold exchange system under which foreign exchange that is convertible to gold is counted as gold in a central bank's reserves.

Where - as was usually the case - those ratios were greater than 1, fluctuations in the gold reserves of a country's central bank led to larger fluctuations in its money supply - often many times as large.