The Four-Pronged Mechanism
Now consider Hume’s theory of international payments equilibrium. Suppose that America runs a large trade deficit and begins to lose gold. According to the quantity theory of prices, this loss of gold reduces America’s money supply, driving down America’s prices and costs..As a result, (1) America decreases its imports of British and other foreign goods, which have become relatively expensive; and (2) because America’s domestically produced goods have become relatively -inexpensive on world markets, America’s exports increase.
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