ABSTRACT
This note is concerned with the welfare costs to a country, to the rest of the world, and to the world as a whole, of the stabilization of the country’s exchange rate in the face of fluctuations in its domestic price level relative to the foreign price level. Such stabilization is effected by the accumulation and decumulation of exchange reserves. In real terms, a surplus in the trade balance used to finance the accumulation of reserves involves a transfer to the rest of the world; and, conversely, the use of reserves to finance the trade deficit involves receipt of a transfer from the rest of the world. If countries are assumed to maintain full employment, it must also be assumed that they follow the domestic policies required to effect such transfers. Specifically it must be assumed that the surplus country arranges to reduce domestic expenditure below the full-employment income level sufficiently to create the excess of income over expenditure required to finance the transfer, and the deficit country arranges to increase domestic expenditures above the full-employment income level sufficiently to create the excess of expenditure over income required to dispose of the transfer.
