Final answer:
Under the international gold standard, a nation's balance of payments deficit will be corrected by an inflow of gold, while a nation's balance of payments surplus will be corrected by an outflow of gold. The correct answer is B.
Step-by-step explanation:
Under an international gold standard, a nation's balance of payments deficit will be corrected by an inflow of gold, while a nation's balance of payments surplus will be corrected by an outflow of gold. This is because under the gold standard, the value of a currency is fixed in terms of a certain amount of gold, so any imbalance in the balance of payments can be rectified by the movement of gold in or out of the country.
The international gold standard fixes a nation's exchange rate through gold reserves, with balance of payments deficits or surpluses corrected by corresponding gold flows. However, this fixed system can lead to economic instability due to rapid changes in financial flows, impacting currency demand and exchange rates.
Understanding the International Gold Standard
Under an international gold standard, a nation's exchange rate is relatively fixed, backed by the assurances of gold reserves. The balance of payments deficit in a country would be self-correcting as the mechanism facilitates an inflow of gold, which in turn helps stabilize the economy by increasing the money supply and encouraging investment. Conversely, a balance of payments surplus would self-correct through an outflow of gold, thus reducing the money supply and potentially cooling down an overheated economy. This system tends to create stability but can also lead to deflationary pressure in surplus countries and inflationary pressure in deficit countries.
However, there are downsides to such a fixed system, as it can lead to economic stress when rapid changes occur in international financial markets. Strong capital inflows might create the expectation of economic prosperity, but sudden outflows can decrease the demand for a country's currency, consequently lowering the exchange rate.
Furthermore, the demand for dollars under the gold standard caused significant fluctuations in gold and currency valuations. Countries like the United States faced challenges in maintaining this balance during periods of extreme trade deficits or when attracting substantial foreign capital.