What are the Two Important Functions of the Gold Standard?

The Gold Standard performs two basic functions:

(1) To control the volume of currency:

Since gold standard requires that currency notes must be backed by gold reserves, the growth of fiduciary note issue (without gold backing) is automatically checked if the government fully abides by the currency laws.

The system of gold standard, thus, at least rudimentarily seeks to ensure that there shall be fewer chances of sudden and arbitrary increases in the volume of the currency.

This may be referred to as the domestic aspect of the gold standard because it is concerned with the internal value of the currency.

(2) To maintain the stability of exchange rates:

Under the system of gold standard, the free (unrestricted) export and import of gold helps in maintaining the exchange rate (external value of the country’s currency) stable.

As Crowther puts is, “the gold standard is a device for ensuring that the demand for and supply of a currency in the exchange market shall always be equal to each other or, more accurately, shall not diverge to such an extent as to cause the exchange rate to move by more than about 1 per cent. It is, in short, a special form of pegging.

The aim of the stability of the external value of the currency of the gold standard is referred to as its international aspect.

These two functions of the Gold Standard are logically quite apart. They are separable in action and conflicting in nature.

For instance, when gold is to be exported to maintain the external value of the currency, it becomes a scarce reserve needed for backing the currency to maintain its internal value stable and vise versa.

To resolve the tie, thus, a country has to keep two sorts of gold reserves, one for keeping it to maintain domestic Gold Standard and the other for use (as exportable surplus) to maintain international Gold Standard.

3. Forms of Gold Standard:

At different times, there have been different forms of Gold Standard. The basic forms of Gold Standard are, however, three, viz. the gold coin standard, the gold bullion standard, and the gold exchange standard.

Among other variants in which currency is defined in terms of gold but convertibility is not permitted and the inflow and outflow of gold is restricted, we have gold reserve standard and gold parity standard.