Milton Friedman

Milton Friedman (July 31, 1912 – November 16, 2006) was an American economist and nobel laureate.

In his "The Case for Flexible Exchange Rates," Friedman argues that fixed exchange rates impede free trade or trade liberalization. Fixed exchange rates constrain the policy actions policy makers can take in order to ensure that the current account and the capital account balance out. The following excerpt articulates why a fixed exchange rate regime impedes trade liberalization:

“It cannot be too strongly emphasized that the structure and method of determining exchange rates have a vital bearing on almost every problem of international economic relations…The only other alternative to movements in exchange rates is direct control of foreign trade. Such control is therefore almost certain to be the primary technique adopted to meet substantial movements in conditions of international trade so long as exchange rates are maintained rigid. The implicit or explicit recognition of this fact is clearly one of the chief sources of difficulty in attempts to achieve a greater degree of liberalization of trade in Europe…”

Friedman points out that with a fixed exchange rate regime states can only achieve a balance of payments by either influencing the cost of domestic-foreign transactions through things like subsidies and tariffs, or by allowing the domestic price level to rise and fall by adjusting the interest rate. He argues that allowing exchange rates to be determined by the market would ensure a balance of payments because exchange rates would adjust automatically to ensure the current account and the capital account balanced out.

References

1. Friedman, Milton. “The Case for Flexible Exchange Rates.” In Essays in Positive Economics, 157-203. Chicago: University of Chicago Press, 1953. Parts IV-V p. 196-197.