Please read"The Return of Britain to the Gold Standard"and answer Questions a) to d)

In 1925, Britain decided to return to the gold standard. The gold standard was a system in which each country xed the price of its currency in terms of gold and stood ready to exchange gold for currency at the stated parity. This system implied fixed nominal exchange rates between countries. The gold standard had been in place from 1870 until World War I. Because of the need to nance the war, and to do so, in part, by money creation, Britain had suspended the gold standard in 1914. In 1925, Winston Churchill, then Brit- ain's Chancellor of the Exchequer {the British equivalent of the Minister of Finance in Canada), decided to return to the gold standard, and to do so at the prewar paritythat is, at the prewar value of the pound in terms of gold. But because prices had increased faster in Britain than in many of its trad- ing partners, returning to the prewar parity implied a large real appreciation: At the same nominal exchange rate as before the war, British goods were now more expensive relative to foreign goods. Keynes severely criticized the decision to return to the prewar parity. In The Economic Consequences of Mr. Churchill, a book he published in 1925, Keynes argued as follows: If Britain was going to return to the gold standard, it should have done so at a higher price of gold in terms of currency, at a nominal exchange rate higher than the prewar nominal exchange rate. In a newspaper article, he articulated his views as follows: There remains, however, the objection to which lhave never ceased to attach importance, against the return to gold in actual present conditions, in view of the possible consequences on the state of trade and employment. l believe that our price level is too high, if itis converted togold at the par of exchange, in relation to gold prices elsewhere; and if we consider the prices of those articles only which are not the subject of inter- national trade, and of services, i.e., wages, we shall find that these are maten'alhr too highnot less than 5%, and probably 10%. Thus, unless the situation is saved by a rise of pnbes elsewhere, the Chancellor is committing us to a policy of forcing down money wages by perhaps 2 shillings in the Pound. l do not believe that this can be achieved with- out the gravest danger to industrial prots and indus- trial peace. l would much rather leave the gold value of our currency where it was some months age than embark on a struggle with every trade union in the country to reduce money wages. It seems wiser and simpler and saner to leave the currency to nd its own level for some time longer rather than force a situation where employers are faced with the alternative of closing down or of lowering wages, cost what the strugle may. For this reason, l remain of the opinion that the Chancellor of the Exchequer has done an ill-judged thingill judged because we are running the risk for no adequate reward if all goes well. Keynes's prediction turned out to be right. While other countries were growing, Britain was in a recession for the rest of the decade. Most economic historians attribute a good part of the blame to the initial overvaluation. Source: Excerpts from The Nation and Athenaeum, May 2, 1925. 0 The New Statesman. Printed by permission. The gold standard system is essentially a fixed exchange rate regime. Instead of fixing the value of currencies to each other, countries fixed the value of their currencies to that of gold. Suppose that in the U.K., the price of one ounce of gold is f5 and in the U.S., the price is $20. Let the U.K. be the domestic country. The nominal exchange rate between the pound sterling and the U.S. dollar is (Note: Please type in decimal.)During World War I, the price in the UK. increased by more than that in the U.S. Following Churchill's suggestion of a return to the gold standard at the prewar parity (i.e., setting the price of one ounce of gold to 5), what is the implication on the real exchange rate compared with the prewar level? Please explain. What was Keynes' suggestion on the nominal exchange rate "if Britain was going to return to the gold standard"? Will the real exchange rate be higher or lower than that in Churchill's suggestion? Please explain. What does the "initial overvaluation" in the last paragraph refer to? Suppose that the M-L condition holds. Please explain why it may have resulted in a recession in the U.K