The gold standard suffers from a series of defects.
1. The main drawback of the gold standard is that it deprives a country of the power to adopt the particular monetary policy which is more appropriate to its internal economic condition, at a time when its monetary policy is subjected to international pressures.
2. Price stability and exchange stability, the two main objectives of monetary policy, cannot be reconciled under the gold standard. Gold standard forces the country to surrender the consideration of price stability. Thus, under the gold standard mechanism exchange rates are stabilised at the expense of internal economic stability and full employment.
3. In the opinion of Halm, the gold standard mechanism is a fair weather craft. The mechanism can function only when the rules of the game are observed. “It is fair weather craft of doubtful seaworthiness in stormy waters. When the necessary conditions cannot be fulfilled, the gold standard is abandoned, and it becomes the task of ‘paper’ standards to manage the bad situation.”
4. It causes violent strains on the economic adjustments of the participating countries to play according to the rules of the game. In fact, international gold standard cannot be regarded as automatic since it is to be managed by the central banks of the countries by following the rules of the gold standard game. Credit contractions and credit expansions as per the rules are to be pursued, which are difficult and dangerous operations. Oftentimes the central bank may not be able to engaged in a policy to reduce costs and prices sufficiently when gold flows out, or to create enough demand for new loans when gold flows in.
5. Mrs. Joan Robinson remarked that the gold standard mechanism suffers from an “inherent bias towards deflation.” For, the mechanism lacks sufficient reciprocity. The gold-losing country will be under legal compulsion to contract the currency but the gold-receiving country is not compelled by law to expand the currency.
Further, it is easy for a central bank to contract credit through bank rate policy and depress investment, but it is difficult to expand credit and stimulate investment. Thus, while the gold-losing country suffers deflation, the gold-receiving country may or may not experience inflation.