Integral stabilization policy and flexible exchange rates

Summary

Under a floating exchange rate system, exchange rates influence economic activity through their effect on the trade balance. Nevertheless, exchange rate movementsper se do not prevent integral fiscal and monetary policies from achieving a target for domestic economic activity²⁴. At the same time, since the exchange rate continuously moves to preserve asset market equilibrium, the (potential) balance of payments may not be equilibrated when the authorities have attained their internal target. In that event, the continued movement in exchange rates may produce cycles in economic activity which in turn lead to exchange rate oscillations. Finally, the reader is warned that the introduction of inside and outside lags into the system may produce additional oscillatory behavior or even explosiveness, as Phillips demonstrated for the closed economy. However, these new possibilities would arise independently of the floating exchange rate system and could not be attributed to it.