Floating exchange rates promote economic stability

Floating exchange rates promote economic stability

A forceful argument put forward by Milton Friedman (1953)in favor of flexible exchange rates is that it is better to let exchange rates adjust in response to shocks to an economy than fix them and force the adjustment onto other economic variables.He argued that floating exchange rates are more conductive to economic stability.The exchange rate is a variable which can easily rise or fall, whereas domestic prices tend to be very difficult to reduce.Hence, if there is a loss of international competitiveness it is better to allow the exchange rate (one price)to depreciate, rather than maintain a fixed exchange rate and require deflationary policies to restore international competitiveness.Since the domestic price level is resistant to downward pressure, it may require quite severe deflationary policies with associated high unemployment to induce the fall in domestic wages and prices necessary to restore international competitiveness.