Humans Adjustment Mechanism
The purpose of an ixchange-rate system is-to proote international “,de and finance while facilitating adjustment to !taocks. How exactly does the intrmational adjustment mechanism function? What happens if a country’s wages and prices rise so sharply that its geods are no longer. competitive in the world market? Under flexible exchange rates, the country’s exchange rate could depreciate to offset the domestic inflation. But under fixed exchange rates, equilibrium must be restored by- deflation at home or inflation abroad.
Let’s examine the international adjustment mechanism under a fixed-exchange-rate system with. two countries, America and Britain. Suppose that American inflation has made American goods uncompetitive. Consequently, America’s imports rise and its .exports fait. It therefore runs a trade deficit .with Britain, To pay for its deficit. America would have to ship gold to Britain. Eventually-e-if there were no adjustments in either America or Britain- America would run out of gold
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