1. Fixed Rate System: Preview of Results
Recall:
i – i* =  - * = Expected deprec of $
When $ can’t depreciate:
i = i* … Monetary discipline
 = * … Price (and wage) discipline

2. Fixed Rate System: How it works
Central bank (CB) buys and sells its currency ($) on foreign exchange markets to keep the exchange rate fixed
It dips into its reserves of “gold” and foreign currencies to buy $ … keep $ from falling
It buys reserves with $ … keep $ from rising
When CB buys $ (sells reserves) M
When CB buys reserves with “new” $
M 

3. Fixed Exchange Rate System: Automatic Adjustment of BoP
Recall: MV = PQ
When S$ > D$ and the Central Bank buys excess $
M  … P  … X  … D$ 
M  … i  … Capital Inflows  … D$ 
M  … i  … Q  … Im  … S$ 
The balance of payments balances

4. Fixed Rate System: Discipline
Wage and price discipline
If W  and P  … D$ 
CB buys $ to keep $ from falling
… M  … P 
Monetary discipline
If M  … P  and i 
… X  and Capital Inflows 
… D$ 
CB buys $ … M 

5. Gold Standard: The Mother of Fixed Rate Systems
Money was either gold coin, currency backed by gold issued by central bank, or bank deposits backed by currency
Each currency’s value was fixed in terms of gold, e.g., 1 oz. of gold = $22
Gold could flow freely internationally
You could redeem your $ for gold, ship the gold to England (or France or wherever), and buy the local currency with the gold

6. Gold Standard: Automatic Adjustment Mechanisms
Humian Mechanism
P  … D$  … BoP Deficit
… Gold Outflow … M  … P 
Interest Rate Mechanism
P  … D$  … BoP Deficit Threatens
… “Bank Rate”  … Capital In
Income Mechanism
… “Bank Rate”  … I  Q  Im 