Abstract

Worldwide Inflation under Flexible

Exchange Rates Basically, a system of flexible exchange rates can lead to the same, a lower or a higher world inflation rate than the world inflation rate in a system of fixed exchange rates. The question examined by the article is: under what special conditions is a system of flexible exchange rates more inflationary than a system of fixed exchange rates. If a certain type of inflation theory, namely the monetary explanation of inflation, is chosen as the relevant inflation theory, the question must be formulated: under what special behaviour assumptions within the system of flexible exchange rates is the growth rate of the world quantity of money greater than in the system of fixed exchange rates. This relatively higher growth rate of the world quantity of money may result from two categories of causes. On the one hand, the system of flexible exchange rates may lead in certain countries to diminished national monetary discipline. On the other hand, acting via certain automatic mechanisms or rigidities, that system in general may produce a systematic, higher world quantity of money. In particular, three reasons for a greater inflationary tendency are examined. The first reason is the desire to reduce the rate of unemployment by way of a higher inflation rate, in so far as the central bank believes in the existence of a Phillips curve and in so far as the optimal choice on the trade-off line results in a higher inflation rate. The second reason relates to a special type of behaviour by the central bank, which pursues an interest-oriented monetary policy of such nature that it permits no reduction of the nominal interest rate as long as the real interest falls in consequence of a higher inflation rate in the rest of the world, or that it endeavours to adjust its own nominal interest rate to that of foreign countries. The third reason is a possible reduction of the desired reserves to be held during the period of transition from a system of fixed exchange rates to one of flexible exchange rates, in so far as an attempt is made to achieve that reduction by way of a higher national price level.