Document Type

Report

Publication Date

3-1975

Number

6

Abstract

Much of the ongoing debate concerning the relative advantages of a fixed vs. a flexible exchange rate regime has centered around the stabilizing or destabilizing effects of speculation and the magnitudes of the elasticities of demand for foreign goods and services (1), Using a "small-country" model which implicitly ignored portfolio balance effects, Mundell (1960) added another dimension to the controversy by demonstrating that the stability properties of either type of exchange rate system depend upon the degree of capital mobility. In particu lar, Mundell shows that when capital is perfectly mobile internationally, a fixed exchange rate ensures a direct approach towards equilibrium while a flexible rate can produce a cyclical approach. In contrast, if capital is immobile, a flexible exchange rate ensures a direct approach towards equilibrium while a fixed rate makes a cyclical approach likely.