Comment on McKinnons's Monetary Rule
- (pp. 113-119)
Abstract[This paper responds to "Monetary and Exchange Rate Policies for International Financial Stability: A Proposal," by Ronald I. McKinnon, in this same issue.] While McKinnon's criticisms of the regime of floating exchange rates are almost entirely justified, I argue that both his analysis and his diagnosis are flawed. His analysis presupposes a very special set of parameters which result in changes in the budget deficit leading to equal changes in the trade balance while leaving output unchanged. In fact, achieving this result requires also changes in relative prices, which are best induced by changes in exchange rates. This points to one of the four important social functions of exchange rate flexibility that are denied or ignored by McKinnon and that would be forfeited under his proposal. In contrast, target zones offer escape from the major costs of floating while retaining the important advantages that flexible rates offer.
Citation1988. "Comment on McKinnons's Monetary Rule." Journal of Economic Perspectives, 2(1): 113-119. DOI: 10.1257/jep.2.1.113
- 431 Exchange Rates and Markets--Theory and Studies
- 432 International Monetary Arrangements