ABSTRACT
Under fixed exchange rates, inflation or deflation starting in any one country quickly spreads to the rest of the world. Under floating rates, inflation and deflation are ‘turned inwards’ (Bernstein) or ‘bottled up’. Depending on circumstances, this well-known fact can be used as an argument either for fixed or for flexible exchange rates. Paolo Baffi and Edward M. Bernstein have used it to defend fixed exchanges. 1 I have tried to refute their argument. 2 My reasons were these: It is true that under fixed exchanges, so long as international reserves are plentiful, a country in recession gets relief by developing an export surplus, i.e. by ‘exporting’ some of the deflation to others. A country in inflation (overfull employment) gets some alleviation by supplementing the flow of real resources through an import surplus, i.e. by ‘exporting’ some of its inflation to others. Under flexible rates, each country has to swallow the inflation or deflation which it generates and cannot escape the discomfort by ‘exporting’ part of the burden to others. 3 But it is not clear why, from the point of view of the world as a whole, this is an unmitigated disadvantage. If under fixed rates one country gets relief from internal discomfort, it is at the expense of others which have to suffer ‘imported’ inflation or deflation. This side of the medal should not be forgotten.
