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Exchange%20Rate%20Systems

Exchange%20Rate%20Systems - FIN 330 Exchange Rate Systems...

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1 FIN 330 Exchange Rate Systems Benefits of a Floating Rate System. At the time floating rates were adopted in 1973, proponents said that the new system would reduce economic volatility and facilitate free trade. In particular, floating exchange rates would offset international differences in inflation rates so that trade, wages, employment, and output would not have to adjust. High-inflation countries would see their currencies depreciate, allowing their firms to stay competitive without having to cut wages or employment. At the same time, currency appreciation would not place firms in low-inflation countries at a competitive disadvantage. Real exchange rates would stabilize, even if permitted to float in principle, because the underlying conditions affecting trade and the relative productivity of capital would change only gradually; and if countries would coordinate their monetary policies to achieve a convergence of inflation rates, then nominal exchange rates would also stabilize. Another benefit is that–as Milton Friedman points out–with a floating exchange rate, there never has been a foreign exchange crisis. The reason is simple: The floating rate absorbs the pressures that would otherwise build up in countries that try to peg the exchange rate while simultaneously pursuing an independent monetary policy. For example, the Asian currency crisis did not spill over to Australia and New
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