Difference between Exchange Stability and Price Stability!
It is easy to see that the various objectives of monetary policy are interrelated. They also usually conflict with one another.
Thus, the objective of price stability may conflict with the objective of exchange rate stability.
Also the attainment of full employment may conflict with the goal of price stability, while the achievement of a high rate of economic growth may not always be compatible with the exchange rate stability and so on.
Exchange Stability vs. Price Stability:
Exchange stability and price stability are the two contradictory goals of monetary policy. It is difficult to pursue them simultaneously. Some economists, therefore, favour exchange stability at the cost of price stability (exchange rate stabilisation). As a matter of fact, however, both these objectives have their relative advantages and disadvantages which we have already discussed in the previous sections.
It has now to be decided which objective should be aimed at. The best course is that a mid-way solution of harmonising both objectives should be aimed at. Then, the question may arise whether it is possible to do so, or whether the two objectives, price stability and exchange stability, are really compatible with each other.
Of course, the above two objectives are contradictory under the gold standard. According to the rule of the gold standard, stability of exchange rates alone should be aimed at and no parallel efforts be made to stabilise the domestic price level. A monetary policy aiming at both will miserably fail in its mission and would achieve nothing.
However, under certain conditions, these two objectives may be found quite consistent and compatible. For instance, the monetary authority can work for both if its gold reserves are sufficiently large to maintain exchange stability, continuing to export gold and not to have recourse to credit contractions, consequent upon such outflow of gold. In such cases, domestic price and economic stability as well as exchange stability can be ensured.
Similarly, a country can sterilise the influx of gold and not allow it to have an inflationary impact on the domestic price level. But, in a strict sense, this amounts to the violation of the rules of the gold standard game.
Secondly, it may be pointed out that both the objectives can be harmonised when the policy adopted by the monetary authority for maintaining stable exchange rates also coincides with the policy of price stabilisation. For instance, if there is an outflow of gold, a contraction of credit is to be initiated according to the rules of the gold standard, which may, however, also become necessary, at the same time, if the economy has been operating at full employment level and internal prices have been rising.
Similarly, an expansionist money policy may be conducive to both exchange stability and price stability when there is an influx of gold in the country and there is need of credit expansion to stimulate investment, employment and prices in the economy. Such a coincidence, however, is rarely observed.
It is sometimes argued that there is no real inconsistency between price stabilisation and exchange stabilisation if the world as a whole could pursue a unified monetary policy by means of close co-operation between the governments or the central banks of different countries, so that equilibrium in the external as well as internal conditions will be maintained throughout.
Though this is an ideal thought, it is very far from being practical In reality, the interpretation of the broad principles and objectives of monetary policy varies from country to country and the result is a disequilibrium which calls for a disharmony between the two accepted objectives, viz., price stability and exchange stability.
In the present era, however, exchange stability is assigned secondary importance as compared to internal price stability because modern States have accepted the prime duty of welfare maximisation and reasonable exchange flexibility is permissible under the ambit of control of the International.
Monetary Fund of which most of the countries are members. In fine, today, the goals of full employment and economic growth have assumed superiority over the stability goal and hence, the object of a monetary policy is to follow a price policy corresponding to the needs of the country concerned in view of its growth and employment policy.