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Gold Standard and Its Advantages and Limitations Definition
Gold Standard and Its Advantages and Limitations Definition
Definition:
1. The gold standard is when a country ties the value of its money to the amount of gold it
possesses.
2. The gold standard is a monetary system where a country's currency or paper money has a
value directly linked to gold.
Anyone holding that country's paper money could present it to the government and receive an (agreed
upon) amount of gold from the country's gold reserve. That amount of gold is called “par value.”
With the gold standard, countries agreed to convert paper money into a fixed amount of gold. A
country that uses the gold standard sets a fixed price for gold and buys and sells gold at that price.
Advantages
1. The benefit of a gold standard is that a fixed asset backs the money's value.
2. It provides a self-regulating and stabilizing effect on the economy.
3. The government can only print as much money as its country has in gold.
4. It also discourages government budget deficits and debt, which can't exceed the supply
of gold
5. A gold standard rewards the more productive nations. For example, they receive gold when
they export. With more gold in their reserves, they can print more money. That boosts
investment in their profitable export businesses.
6. The gold standard spurred exploration. It's why Spain and other European countries
discovered the New World in the 1500s. They needed to get more gold to increase their
prosperity. It also prompted the Gold Rush in California and Alaska during the 1800s.
Disadvantages
1. One problem with a gold standard is that the size and health of a country's economy are
dependent upon its gold.
2. The economy is not reliant on the resourcefulness of its people and businesses but solely
dependent on gold
3. Countries without any gold were in disadvantageous position.
4. The United States never had that problem. It's the world's second-largest gold mining country
after South Africa. Australia, Canada and many developing countries also are major gold
producers.
5. The gold standard makes countries obsessed with keeping their gold. They ignore the more
important task of improving the business climate.
6. Government actions to protect their gold reserves caused significant fluctuations in the
economy. In fact, between 1890 and 1905, the U.S. economy suffered five major recessions
(slowdown) for this reason.
Definition:
The current account is a country's trade balance plus net income and direct payments.
The current account records
1. Exports and imports of goods and services as well as International transfers.
2. International transactions of purchase and sale of foreign assets and liabilities during a
particular year. The goal for most countries is to accumulate money by exporting more goods
and services than they import. That’s called a trade surplus.
3. It means a country will take in more earnings. A deficit occurs when a country's government,
businesses and individuals export fewer goods and services than they import.
4. The current account is part of a country's balance of payments.
1. Trade: Trade in goods and services is the largest component of the current account. Therefore,
a trade deficit is enough to create a current account deficit.
2. Net Income: This is income received by the country’s residents minus income paid to
foreigners. The country’s residents receive income from two sources.
The first is earned on foreign assets owned by a nation's residents and businesses. That includes
interest and dividends earned on investments held overseas.
The second source is income earned by a country's residents who work overseas.
Income paid to foreigners is similar. The first category is interest and dividend payments to
foreigners who own assets in the country. The second is wages paid to foreigners who work in the
country.
If the income received by a country's individuals, businesses and government from foreigners is more
than the income paid out, then net income is positive. If it is less, then it contributes to a deficit.
Direct transfers also include a government's direct foreign aid. For example, the United States
spends $22 billion a year on foreign aid. That adds to America's $502 billion current account deficit,
the largest in the world.
A third direct transfer is foreign direct investments. That's when a country's residents or businesses
invest in businesses in foreign countries.
4. Asset Income: This is composed of increases or decreases in assets like bank deposits, central
bank and government reserves, securities and real estate. For example, if a country’s assets do well,
asset income will be high.
The current account deals with short-term The capital account is a record of the inflows and
transactions known as actual transactions, as outflows of capital that directly affect a country’s
they have a real impact on income, output and foreign assets and liabilities.
employment levels of a country through the
movement of goods and services in the It is concerned with all international trade
economy. transactions between citizens of a given country
It is comprised of visible trade (export and and citizens in other countries.
import of goods), invisible trade (export and
import of services), unilateral transfers, and
investment income (income from factors such
as land or foreign shares).
The resulting balance of the current account is
approximated as the sum total of balance of
trade.
In economic terms, the current account deals In economic terms, the capital account reflects
with receipt and payment in cash as well as sources and utilization of capital.
non-capital items, and the capital account
reflects sources and utilization of capital.
An open economy can therefore buy and sell assets in the financial markets, generating flows of capital.
When the net capital outflow is positive, domestic residents are buying more foreign assets than
foreigners are purchasing domestic assets. When it’s negative, foreigners are purchasing more domestic
assets than residents are purchasing foreign assets.
Imbalances in the net capital outflow (NCO) are associated with imbalances in the trade balance (or net
exports, NX), following the identity NCO = NX.
Each exchange that affects the net capital outflow, also affects net exports in the same amount. For
instance, if an economy is running a trade deficit, it must be financing the net purchase of goods and
services by selling assets abroad. If it’s running a trade surplus, the excess in foreign currency it receives
is being used to buy assets from abroad.
Since net capital outflows are related to net exports, they are therefore related to gross domestic
production.
From the equation showing the relationship between the current account, savings and investment, we
have:
S = I + NX = I + NCO
where
S = savings
I = domestic investment
NX = net exports
NCO = net capital outflows
From these equations, we can derive an easy-to-use cheat sheet about international flows of goods,
services and investment:
1. Issuer of currency : The RBI has the sole right to issue currency notes except one rupee notes
which are issued by the Ministry of Finance. This concentration of notes issue function with the
Reserve Bank has a number of advantages: (i) it brings uniformity in notes issue; (ii) it makes
possible effective state supervision; (iii) it keeps faith of the public in the paper currency.
2. Banker to Government: Just like individuals need a bank to carry out their financial transactions
effectively & efficiently, Governments also need a bank to carry out their financial transactions.
RBI serves this purpose for the Government of India (GoI). As banker to the government the
Reserve Bank manages the banking needs of the government. It represents the Government of
India as the member of the IMF and the World Bank.
3. Monetary Authority: Formulates, implements and monitors the monetary policy for A)
maintaining price stability, keeping inflation in check ; B) ensuring adequate flow of credit to
productive sectors.
4. Custodian of Cash Reserves of Commercial Banks: The commercial banks hold deposits in
the Reserve Bank and the RBI has the custody of the cash reserves of the commercial banks.
5. Custodian of Country’s Foreign Currency Reserves: The RBI has the custody of the country’s
reserves of international currency, and this enables the Reserve Bank to deal with crisis.
6. Lender of Last Resort: The commercial banks approach the Reserve Bank in times of
emergency when there is financial difficulties, and the RBI comes to their rescue though it might
charge a higher rate of interest.
7. Banker's bank and supervisor: RBI also works as banker to all the scheduled commercial
banks. All the banks in India maintain accounts with RBI which helps them in clearing & settling
inter bank transactions and customer transactions smoothly.
7. Regulator of the Banking System: RBI has the responsibility of regulating the nation's financial
system. As a regulator and supervisor of the Indian banking system it ensures financial stability &
public confidence in the banking system.
The WBG came into formal existence in 1945 and commenced its operations in 1946, it approved its
first loan on May 1947 (US$ 250M to France for post-war reconstruction, in real terms the largest loan
issued by the Bank to date). The bank's goal is to achieve the twin goals of ending extreme poverty
and building shared prosperity.
The term "World Bank" generally refers to just the IBRD and IDA, whereas the term World Bank
Group or WBG is used to refer to all five institutions collectively.
The IBRD has 189 member governments, and the other institutions have between 153 and 184
members.
World Bank Group is run by a Board of Governors meeting once a year. Each member country
appoints a governor, generally its Minister of Finance. On a daily basis the World Bank Group is run
by a Board of 25 Executive Directors to whom the governors have delegated certain powers. Each
Director represents either one country (for the largest countries), or a group of countries. Executive
Directors are appointed by their respective governments or the constituencies. Traditionally, the Bank
President has always been a U.S. citizen nominated by the President of the United States, the largest
shareholder in the bank. The nominee is subject to confirmation by the Board of Governors, to serve
for a five-year, renewable term.
The World Bank's (the IBRD and IDA's) activities are focused on developing countries, in fields such
as human development (e.g. education, health), agriculture and rural development (e.g. irrigation and
rural services), environmental protection (e.g. pollution reduction, establishing and enforcing
regulations), infrastructure (e.g. roads, urban regeneration, and electricity), large industrial
construction projects, and governance (e.g. anti-corruption, legal institutions development). The IBRD
and IDA provide loans to member countries, as well as grants to the poorest countries. Loans or
grants for specific projects are often linked to wider policy changes in the sector or the country's
economy as a whole. For example, a loan to improve coastal environmental management may be
linked to development of new environmental institutions at national and local levels and the
implementation of new regulations to limit pollution.
The current buffer norms were revised in January 2015. According to the new norms, the
central pool should have 4 crore tonnes of rice and wheat and 3 crore tonnes every year. The
reason for increased buffer stocks due the increase in demand from TPDS (ration shops)
system and also enactment of National Food Security Act.
FCI buys almost one third of the total rice and wheat produced in the country at minimum
support prices! It does not say no to any farmer who wants to sell his produce at MSP. Earlier,
once the buffer norms were met, cabinet approval was needed to sell remaining stock in the
open market. But then, in January 2015; this situation changed. The current policy is that Food
Ministry is authorized to dispose the surplus stock into open market without seeking cabinet
approval.
The Food Corporation of India (FCI) was setup under the Food Corporation Act 1964. FCI buys
the grains from the farmers and stores it in its granaries Its objectives are:-
Effective price support operations for safeguarding the interests of the farmers.
Distribution of food grains throughout the country for public distribution system.
Maintaining satisfactory level of operational and buffer stocks of food grains to ensure
National Food Security.
In its 40 years of service to the nation, FCI has played a significant role in India's
success in transforming the crisis management oriented food security into a stable
security system.
The functioning of the FCI:-
The FCI pays the farmers a price that is already fixed by the Government.
This price is called Minimum Support Price (MSP) The MSP is announced by the
government every year before the sowing season
The announcement of the price helps farmers to plan their agricultural activity and
increase production.
INFLATIONARY SPIRAL
Case 1 : Increase in wage leads to higher product cost thus price rise (inflation).
Definition
1. The situation in which price and income increases may each induce further rises in the
other
2. A cycle of worsening inflation as higher prices results in higher wages, increasing costs
and resulting in still higher prices.
3. The wage-price spiral is a macroeconomic theory used to explain the cause-and-effect
relationship between rising wages and rising prices, or inflation. The wage-
price spiral suggests that rising wages increases disposable income, thus raising the
demand for goods and causing prices to rise.
It is also known as Wage- Price Spiral. It is the cause effect relationship between rising prices
and rising wages. Wage chases prices and vice versa.
W-P spiral suggest that rising wages increase disposable income, thus raising the demand for
goods and causing prices to increase. Rising prices cause demand for higher wages, which
leads to higher production costs and further increase pressure on prices.
Self-sustaining upward trend in general price levels fueled by the reinforcing feedback of a
vicious circle. Wage price spiral is a typical example of an inflationary spiral: high cost of living
prompts demands for higher wages which push production costs up forcing firms to increases
prices, which in turn trigger calls for fresh wage increases ... and so on. Such situations
continue until radical measures (such as incomes policy) are instituted to break the cycle,
otherwise the currency is rendered almost worthless as a medium of exchange (as it happened
in Germany in the 1920s, in Brazil in the 1980s, and in Argentina in the 1990s) and has to be
replaced with new monetary units (currency).
The expenditure method is a method for calculating gross domestic product (GDP), which totals
consumption, investment, government spending and net exports.
The expenditure method is the most common way to estimate GDP, and it says everything that
the private sector, including consumers and private firms, and government spend within the
borders of a particular country must add up to the total value of all finished goods and services
produced over a certain period of time.
In the United States, the most dominant component in the calculations of GDP under the
expenditure method is consumer spending, which accounts for the majority of U.S.
GDP. Consumption is typically broken down into purchases of durable goods (such as
cars and computers), non-durable goods (such as clothing and food), and services.
Business investment is one of the most volatile components that goes into calculating
GDP. It includes capital expenditures by firms on assets with useful lives of more than
one year each, such as real estate, equipment, production facilities and plants.
The last component included in the expenditure approach is net exports, which
represents the effect of foreign trade of goods and service on the economy.
GDP, which can be calculated using numerous methods, including the expenditure approach, is
supposed to measure a country's standard of living and economic health. Critics such as the
Nobel Prize-winning economist Joseph Stiglitz caution that GDP should not be taken as an all-
encompassing indicator of a society's well-being, since it ignores important factors that make
people happy. For example, while GDP includes monetary spending by private and government
sectors, it does not consider work-life balance or the quality of interpersonal relationships in a
given country.
Issue Price
The price at which a new security will be distributed to the public prior to the new issue trading
on the secondary market. Also commonly referred to as offering price.
Minimum Support Price is the price which is announced before the crop sowing. This the price
at which government is required to buy the crop whether the market price is less or more. GoI
announcing it since 1966-67.
Procurement price is announced after the harvesting and it is higher than MSP. Since the
fiscal 1968- 69 the government announced only the Minimum Support Price which is also
considered as procurement price.
Finally, the Issue Price is the one at which goods are released from FCI (Food Corporation of
India). Here, the difference between MSP and Issue Price is called SUBSIDY.
For Example: Let’s say the MSP of Wheat is 10/Kg. The issue price of wheat from FCI to
general population is 2/Kg. The balance 10-2= 8 is the subsidy amount. This subsidy
component is borne by Government.
The food grains procured and stored by the government are distributed in food-deficit areas and
among the poorer strata of society at a price lower than the market price. This price is known as
issue price.
Example 1 : From 2002 onwards, there was huge inflow of foreign capital into India. This led to
appreciation of rupee. Since appreciation is not good for exports, the RBI intervened in the
foreign exchange market by buying dollars. To buy dollars, the RBI has to give rupees. In this
way, high selling of rupees leads to excess rupee and thereby created a potential for inflation.
To overcome this situation, the RBI has sold government bonds. Here bonds go to financial
institutions and money goes back to the RBI. This withdrawal of excess liquidity is called
sterilisation. During 2007-08 alone, RBI sold Rs 2.5 lakh crore worth of securities implying that
Rs 2.5 lakh crore money supply sterilised. Following facts are important to understand MSS.
In the words of D.C. Rowan, “The monetary policy is defined as discretionary act undertaken by the authorities
designed to influence (a) the supply of money, (b) cost of money or rate of interest, and (c) the availability of
money for achieving specific objective.”
In developing countries monetary policy has to play a significant role in promoting economic growth. As Prof.
R. Prebisch writes, “The time has come to formulate a monetary policy which meets the requirements of
economic development, which fits into its framework perfectly.” Further, along with encouraging economic
growth, the monetary policy has also to ensure price stability, because the excessive inflation not only has
adverse distribution effect but hinders economic development also.
Thus, monetary policy of India refers to that policy which is concerned with the measures taken to regulate the
credit created by the banks. In developed countries the monetary policy has been usefully used for overcoming
depression and inflation.
3. To ensure stability of exchange rate of the rupee, that is, exchange rate of rupee with the US dollar, pound
sterling and other foreign currencies.
In order to prevent large depreciation and appreciation of foreign exchange rate Reserve Bank has to take
suitable monetary measures to ensure foreign exchange rate stability. Today, the exchange rate of rupee is
determined by demand for and supply of foreign exchange (say, US dollar). When there is mismatch between
demand for and supply of foreign exchange, external value of rupee changes. to prevent the depreciation of
the rupee, Reserve Bank can release more dollars from its foreign exchange reserves. The release of more
dollars by Reserve Bank will increase the supply of US dollars in the foreign exchange market and will
therefore tend to correct the mismatch between demand for and supply of the US dollars. This will help in
stabilising the exchange rate of the rupee.
The main aim of the monetary policy of the Reserve Bank was to control the money supply in such a manner
as to expand it to meet the needs of economic growth and at the same time contract it to curb inflation. In other
words monetary policy aimed at expanding and contracting money supply according to the needs of the
economy.
x. To Develop Infrastructure:
Monetary policy aims at developing infrastructure. It provides concessional funds for developing infrastructure.
'Tapering'
Tapering is the gradual winding down of central bank activities used to improve the conditions
for economic growth. Tapering activities are primarily aimed at interest rates and at the
management of investor expectations regarding what those rates will be in the future. These
can include changes to conventional central bank activities, such as adjusting the discount
rate or reserve requirements, or more unconventional ones, such as quantitative easing (QE).
Central banks can employ a variety of policies to improve growth, and they must balance short-
term improvements in the economy with longer-term market expectations. If the central bank
tapers its activities too quickly, it may send the economy into a recession. If it does not taper its
activities, it may lead to high inflation.
These are those banks which are owned and run by private
Private Sector Banks
entities.
National Housing Bank ( NHB) is the apex body which take care
of all the matters related with the housing finance. It is wholly
Housing Development
owned by RBI. Popular examples of these banks are
Banks
Housing Development FinanceCorporation ( HDFC), Dewan
Housing Finance Limited ( DHFL) etc.
In previous post we explained about the evolution of banking system in India. Now this was all
about categorization of banks in India under various heads. We will soon publish other
relevant study materials like functions of commercial banks, types of accounts , technology in
banking sector etc. and it will be strictly according to the syllabus prescribed by IBPS and SBI.