View source for Finance:Price–specie flow mechanism

The '''price–specie flow mechanism''' is a model developed by Scottish economist [[Biography:David Hume|David Hume]] (1711–1776) to illustrate how trade imbalances can self-correct and adjust under the [[Chemistry:Gold standard|gold standard]]. Hume expounded his argument in ''[[Finance:Of the Balance of Trade|Of the Balance of Trade]]'', which he wrote to counter the Mercantilist idea that a nation should strive for a positive [[Finance:Balance of trade|balance of trade]] (i.e., greater exports than imports). In short, the "increase in domestic prices due to the gold inflow would discourage exports and encourage imports, thus automatically limiting the amount by which exports would exceed imports".<ref name="econlib">{{cite web|title=David Hume|url=http://www.econlib.org/library/Enc/bios/Hume.html|website=Library of Economics and Liberty|publisher=The Concise Encyclopedia of Economics|accessdate=8 February 2018}}</ref>

Hume first elaborated on the mechanism in a 1749 letter to [[Biography:Montesquieu|Montesquieu]].<ref name="studies">{{cite journal|author1=Robert W. McGee|title=The Economic Thought of David Hume|journal=Hume Studies|date=1989|volume=15|issue=1|pages=184–204|url=http://www.humesociety.org/hs/issues/v15n1/mcgee/mcgee-v15n1.pdf}}</ref>

== Argument ==

Hume argued that when a country with a gold standard had a positive balance of trade, gold would flow into the country in the amount that the value of exports exceeds the value of imports. Conversely, when such a country had a negative balance of trade, gold would flow out of the country in the amount that the value of imports exceeds the value of exports. Consequently, in the absence of any offsetting actions by the [[Finance:Central bank|central bank]] on the quantity of money in circulation (called [[Finance:Sterilization (economics)|sterilization]]), the money supply would rise in a country with a positive balance of trade and fall in a country with a negative balance of trade. Using a theory called the [[Finance:Quantity theory of money|quantity theory of money]], Hume argued that countries with an increasing money supply would see [[Finance:Inflation|inflation]] as the prices of goods and services rose while countries with a decreasing money supply would experience [[Finance:Deflation|deflation]] as the prices of goods and services fell.<ref name="uneasy">{{cite news|title=What’s Wrong with the Price-Specie-Flow Mechanism? Part I|url=https://uneasymoney.com/2017/07/07/whats-wrong-with-the-price-specie-flow-mechanism-part-i/|accessdate=8 February 2018| work=Uneasy Money|date=7 July 2017}}</ref>

The higher prices would, in the countries with a positive balance of trade, cause exports to decrease and imports to increase, which will alter the balance of trade downwards towards a neutral balance. Inversely, in countries with a negative balance of trade, the lower prices would cause exports to increase and imports to decrease, which will heighten the balance of trade towards a neutral balance. These adjustments in the balance of trade will continue until the balance of trade equals zero in all countries involved in the exchange.<ref>Murray N. Rothbard, [https://mises.org/library/david-hume-and-theory-money David Hume and the Theory of Money"], Mises Daily Articles, 27 April 2011.</ref>

The price–specie flow mechanism can also be applied to a state's entire balance of payments, which accounts not only for the value of net exports and similar transactions (i.e., the [[Finance:Current account (balance of payments)|current account]]), but also the financial account, which accounts for flows of financial assets across countries, and the [[Finance:Capital account|capital account]], which accounts for non-market and other international [[Finance:Financial transaction|transactions]]. But under a [[Chemistry:Gold standard|gold standard]], transactions in the financial account would be conducted in gold—or [[Finance:Currency|currency]] convertible into [[Chemistry:Gold|gold]]—which would also affect the quantity of money in circulation.{{cn|date=February 2018}}

==References==
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[[Category:Preclassical economics]]
[[Category:Gold standard]]



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