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Question
Explain the automatic mechanism by which BoP equilibrium was achieved under the gold standard.
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Solution
Under the gold standard system, gold was taken as a common unit for measuring other country’s currency. Thus, the value of a currency was defined in terms of gold. The exchange rate in an open market was determined by its worth in terms of gold. It was fixed in lower limits and upper limits, under which it was allowed to fluctuate. So, the exchange rate became stable under gold standard. All the countries maintained stock of gold to exchange currency.
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