Read an Academic Passage

The Function of the Gold Standard

The classical gold standard was a monetary system that was widely used from the 1870s until the outbreak of World War I. Under this system, the value of a country's currency was legally defined as a fixed quantity of gold. The government would guarantee this convertibility, meaning that any individual could, in theory, exchange their paper money for its equivalent value in gold. This link to a physical commodity was intended to ensure the currency's value and provide economic stability.

One of the main perceived benefits of the gold standard was its ability to maintain price stability and prevent high inflation. Because the money supply was limited by the amount of gold a nation held in its reserves, governments were unable to print money excessively. This imposed a strict discipline on their fiscal and monetary policies. Additionally, the system created a network of fixed exchange rates between countries, which was thought to foster international trade by reducing currency risk for importers and exporters.

Despite these advantages, the gold standard had significant drawbacks. Its inflexibility made it difficult for governments to respond to economic shocks. During a recession, for example, a government could not increase the money supply to stimulate economic activity. A country's economic growth was also constrained by its gold supply. Following the economic turmoil of the Great Depression and the World Wars, most nations abandoned the gold standard in favor of more flexible fiat money systems, where a currency's value is not backed by a physical commodity.