chapter  9
28 Pages

Nontariff distortions to trade

This chapter demonstrates perfect capital mobility that implies different concepts of stabilization policy. Monetary policy has no impact on employment under fixed exchange rates while fiscal policy has no effect on employment under flexible exchange rates. The chapter explains how the overall economy and economic policy change when the exchange rate is not allowed to float freely. The demand and supply of foreign currency determines the fixed exchange rate posted by the government. The chapter examines the situation where intervention in the foreign exchange market is not allowed to change the money supply. For more than 20 years, the European Union has been attempting to achieve the degree of exchange rate stability within Europe that the old Bretton Woods system had. As trade barriers fell in Europe and trade increased, the instability of exchange rates became increasingly important as a deterrent to both trade and investment.