Monday 6 August 2012

Fixed v.floating exchange rates

There is an on going debate over which of fixed or floating exchanges rate is best. At the Free Banking blog Kurt Schuler writes on Milton Friedman's views on exchange rates. He writes
The key to reconciling Friedman’s apparently contradictory positions is to understand that clean fixed and clean floating exchange rates, though differing in their degree of nominal rigidity, are similar in that both give market forces free rein. Under a clean fixed exchange rate, the nominal exchange rate is fixed and market forces determine the nominal monetary base. Under a clean floating exchange rate, the nominal monetary base is in the short term fixed (or perhaps a better word would be "set") and market forces determine the nominal exchange rate.
The important thing to take from this is that clean forms of both exchange rate systems work. But keep in mind the word clean in that sentence. In the real world nether system is clean so the real question is which system works best when governments intervene?

Schuler goes on the write,
The overall impression Friedman's statements on exchange rates leave is that he considered flexible exchange rates to be the system most desirable and most politically sustainable for large and medium-size economies that were politically independent and able to keep inflation relatively low.
Does New Zealand meet these conditions?

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