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BPEA Article

Dealing with the Trade Deficit in a Floating Rate System

Abstract

THE VOLATILITY of the dollar in the last several years has led to serious second thoughts worldwide about the desirability of a system of floating exchange rates. The emergence of dissatisfaction was predictable. The exchange rate is the most important price of any nation's economy after the wage rate, and the wage rate is splintered into thousands of fragments. Firms are deeply upset by price movements they do not understand. Economists may have the best of the argument when they say that the total uncertainty in the economic system is not increased by flexible exchange rates, although even that judgment depends on assessments of the extent to which an exchange rate commitment can "discipline" national economic policies and also on the prevalence of autonomous bandwagon movements in the foreign exchange market. But that conclusion is no consolation to those in the goods-producing heart of the economy who feel directly the impact of foreign price fluctuations. For them uncertainty has risen, and I predict that it will prove to be intolerable and that they will insist on political action to reduce it.

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