The Optimum Foreign Exchange Market: Comment.

Recently Jerome L. Stein has presented a theory of the optimum foreign exchange market to demonstrate "how social welfare criteria can be used to evaluate the desirability of alternative foreign exchange markets." Arguing on the basis of a simple model, he is able to obtain conclusions of far-reaching significance. For an economy with idle resources, he concludes, a free exchange market is more efficient than a stabilized exchange market if the balance of payments tends towards deficits in periods of output contraction and surpluses in periods of output expansion; on the other hand, a stabilized exchange market is more efficient than a free exchange market, if the balance of payments tends towards surpluses in periods of output contraction and deficits in periods of output expansion. For a full-employment export economy with fluctuating productivity, a foreign exchange market stabilized at the "equilibrium rate" is found to be more efficient than a free exchange market. Thus, it appears that the long and arduous controversy over the relative desirability of freely flexible and fixed exchange rates has found a startlingly simple solution, depending upon the "structure" of the economy in question, Stein's theory would permit an unequivocal choice between the two types of exchange-rate systems.