Freely Flexible Exchange Rates

Paul Davidson

Chapter 14 in International Money and the Real World, 1982, pp 260-265 from Palgrave Macmillan

Abstract: Abstract In the normal course of events, even if fixed exchange rates are set so that over a period of years total outpayments from nation A to nation B equalled inpayments from B to A, there is little likelihood that in each subperiod an exact payments balance could be maintained. In an uncertain world, there will be oscillations in the trade balance merely because of seasonal factors, or variations in stockpiling, or different phases of the production and business cycle in each nation, etc. As long as exchange rates are fixed and are expected to move no more than a small percentage one way or the other (e.g. between gold export and import points), a large measure of the discrepancy between the value of exports and imports in any subperiod will be offset by movements in private funds. During a temporary trade deficit period, for example, importers and exporters will observe that the deficit nation’s currency is relatively cheap. Since these individuals will always have a schedule of contractual payments coming due in the future, they will find it in their best interests to buy the deficit nation’s currency spot as long as they expect to have an obligation due at a future date when they expect the exchange rate to return towards its ‘normal’ level. Similarly, bankers who hold funds in various nations for precautionary and speculative purposes, even if they have no expected contractual obligations coming due in the deficit nation’s currency, will buy the cheap currency spot, while those who already hold nation’s A currency will try to rearrange scheduled payments on international contracts denominated in B’s currency to avoid selling A’s money while it is ‘temporarily’ depressed. Harrod has termed the sum total of such financial movements ‘the adjustment of balances and the leads and lags in trade payments’.1

Keywords: Exchange Rate; Trade Balance; Foreign Exchange Market; Flexible Exchange Rate; Income Policy (search for similar items in EconPapers)
Date: 1982
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DOI: 10.1007/978-1-349-16679-4_14

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