Domestic Financial Policies Under Fixed and Under Floating Exchange Rates

T HE BEARING of exchange rate systems on the relative effectiveness of monetary policy on the one hand, and of budgetary policy on the other, as techniques for influencing the level of monetary demand for domestic output, is not always kept in mind when such systems are compared. In this paper it is shown that the expansionary effect of a given increase in money supply will always be greater if the country has a floating exchange rate than if it has a fixed rate. By contrast, it is uncertain whether the expansionary effect on the demand for domestic output of a given increase in budgetary expenditure or a given reduction in tax rates will be larger or smaller with a floating than with a fixed rate. In all but extreme cases, the stimulus to monetary demand arising from an increase in money supply will be greater, relative to that arising from an expansionary change in budgetary policy, with a floating than with a fixed rate of exchange.