The Merits and Demerits of Paper Standard are given below:
Merits of Paper Standard
Since under paper standard no gold coins are in circulation and no gold reserves are required to back paper notes, it is the most economical form of monetary standard. Even the poor countries can adopt it without any difficulty.
2. Proper Use of Gold:
Wastage of gold is avoided and this precious metal becomes available for industrial, art and ornamental purpose.
3. Elastic Money Supply:
Since paper money is not linked with any metal, the government or the monetary authority can easily change the money supply to meet the industrial and trade requirements of the economy.
4. Ensures Full Employment and Economic Growth:
Under paper standard, the government of a country is free to determine its monetary policy. It regulates its money in such a way that ensures full employment of the productive resources and promotes economic growth.
5. Avoids Deflation:
Under paper standard, a country avoids deflationary fall in prices and incomes which is the direct consequence of gold export.
Such type of situation arises under gold standard when a participating country experiences adverse balance of payments. This results in the outflow of gold and contraction of money supply.
6. Useful During Emergency:
Paper currency is very useful in times of war when large funds are needed to finance war. It is also best suited to the less developed countries like India. To these economies, it makes available large amounts of financial resources through deficit financing for carrying out developmental schemes.
7. Internal Price Stability:
Under this system, the monetary authority of a country can establish stability in the domestic price level by regulating money supply in accordance with the changing requirements of the economy.
8. Regulation of Exchange Rate:
Paper standard provides more effective and automatic regulation of exchange rate, whereas, under gold standard, the exchange rate is absolutely fixed.
Whenever, exchange rate fluctuates as a result of disequilibrium between demand and supply forces, the paper standard works on imports and exports and restores equilibrium. It allows the forces of demand and supply to operate freely to establish equilibrium.
Demerits of Paper Standard
The paper standard suffers from the following defects:
1. Exchange Instability:
Since the currency has no link with any metal under paper currency, there are wide fluctuations in the foreign exchange rates. This adversely affects the country’s international trade. Exchanging instability arises whenever external prices move more than domestic prices.
2. Internal Price Instability:
Even the commonly claimed advantage of paper standard, i.e., domestic price stability, may not be achieved in reality. In fact, the countries now on paper standard experience such violent fluctuations in internal prices as they experienced under gold standard before.
3. Dangers of Inflation:
Paper standard has a definite bias towards inflation because there is always a possibility of over- issue of currency. The government under paper standard generally has a tendency to use managed currency to cover up its budget deficit. This results in inflationary rise in prices with all its evil effects.
4. Dangers of Mismanagement:
Paper currency system can serve the country only if it is properly and efficiently managed. Even the minor mistake in the management of paper currency can bring such disastrous result that cannot be conceived of in any other form of monetary standard.
If the government issues little more or little less currency than what is required for maintaining price stability, it may lead to cumulative inflation or cumulative deflation.
5. Limited Freedom:
In the present world of economic dependence, it is almost impossible for a particular country to isolate itself and remain unaffected from the international economic fluctuations simply by adopting paper standard.
6. Absence of Automatic Working:
The paper standard does not function automatically. To make it work properly, the government has to interfere from time to time.