By early traditional economics external payments were supposed to come into balance automatically. If a metallic standard was in operation and notes were convertible, gold or silver would flow in or out and make up the difference between the plusses and minuses of international payments, when these were not in balance. These flows operated on the domestic price level by changing the size of the internal money supply. An outward flow would depress domestic prices, thereby stimulating exports and discouraging imports, and conversely. This process would reduce and finally eliminate the external gap, at which point the flow of metal would cease.
KeywordsExchange Rate Foreign Trade Price Elasticity Money Supply Income Elasticity
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