Britton, A.J.C.
March 1970
Economic Journal;Mar70, Vol. 80 Issue 317, p91
Academic Journal
Within the limitations of a simple model of the exchange market, it can be shown that if the exchange rate were left free to find its own level dynamic instability would be a real possibility in the absence of speculation. The market might be expected to clear very rapidly, and the prices of traded goods would probably respond more rapidly than the volumes; this would tend to create instability. On the other hand, experience suggests that the elasticity of the terms of trade with respect to the exchange rate is likely to be less than unity, which would make stability more likely. Even if the market were stable, however, it would almost certainly be cyclical. Perhaps the most optimistic view of speculators is that they know the long-run equilibrium value of the exchange rate and will buy a currency whenever its value is below that level. Such behaviour will always stabilise the market if speculators respond sufficiently actively and have sufficient funds at their disposal. The responsiveness and the volume of funds required could be estimated from a knowledge of the lags in real trade flows. Finally, a formula for adjusting the exchange rate in line with payments disequilibria, which did not amount to continuous clearing of the market, would be more likely to be dynamically stable. In general, the slower the adjustment of the rate, the more probable would be the stability of the system.


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