chapter  3
20 Pages

International consequences of bloc floating

In his famous defence of flexible exchange rates, Friedman (1953a) argued that flexibility was not equivalent to instability. If rates were free to vary, they would help to correct any surplus or deficit in the balance of payments and this fact would contribute to making exchange rates ‘highly stable’. Thus, instability of exchange rates was a symptom of instability in the underlying economic structure. Speculators in the market were assumed to distinguish between temporary balance of payment disequilibria and fundamental factors with a likelihood of being permanent. Financial markets would moderate the transitory variation by taking positions against the trend, but they would speed up fundamental adjustment by moving in the direction of the new equilibrium.