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Critical Evaluation of Milton Friedman's ViewsIn this essay, we will evaluate Friedman's view that using the freemarket is the best way to achieve a balance of payments euilibrium!"he evaluation will be done with particular reference to the othermacroeconomic ob#ectives of sustained economic growth, lowunemployment and stable prices!

Firstly, Friedman looks at the possibility of drawing on reserves orborrowing from abroad! $e argues that this would be undesirablemainly because this essentially sees less demand for e%portscompeting with imports, and hence reduces industrial output!Employment decreases as a result, harming consumption andeconomic growth!

I would argue that it depends on what is being imported! Fore%ample, countries like &rail and India who see large F(I inflowsmay in the short run suffer from a current account deficit, but in thelong run benefit from an increase in capital accumulation! "hisstimulates labour productivity and meaning firms have lower costs,hence becoming more competitive internationally! It helpss correct abalance of payments deficit and increased e%ports demand increasesindustrial output, and hence employment!

)econdly, lowering prices through lowering inflation can stimulatee%ports and discourage imports! $owever, Friedman argues that thiscan only be achieved by tight monetary policy or fiscal policy e!g!raising interest rates to make it more e%pensive for consumer and

business borrowing, hence reducing consumption! "he significantfall in *( needed to achieve lower inflation can lead to recessionand increase cyclical unemployment as firms find themselves withe%cess spare capacity!

+n the other hand, this depends on what stage of the economic cyclea country is in! For e%ample, the - economy pre.recession mayhave benefited from even higher interest rates to deter consumption,and hence lower demand pull inflation! Friedman is being toogeneral in his argument that lowering domestic consumption harmsour macroeconomic ob#ectives!

"hirdly, with fi%ed e%change rates one can officially devalue acurrency, such as when &ritain devalued the sterling! Ceteris paribusthis makes a country's e%ports cheaper and more competitive andimports more e%pensive! Friedman's main argument is that changesin rates are often postponed, hence worsening the situation/ in 0112the prospect of the sterling's devaluation prompted flight from thecurrency, hence putting more pressure upon the 3&4 to devalue!

5ust because changes in rates are often postponed doesn't mean thereis a problem with an e%change rate system though, merely that the

system is being mismanaged! In cases such as the sterling'sabandonment of the E6M in 0112, the &ank of England should haveacted much uicker to react to a long term over.valuation of the

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3&4! China's e%perience with a fi%ed e%change rate proves that withgood management, a country can combine increased short termstability with long run sustainability!

Floating e%change rates are seen by Friedman as the panacea to acurrent account deficit! $e argues that under this method e%change

rates ad#ust themselves using the free market, and indeed speaksagainst any government intervention in the currency market!Friedman argues that the government is #ust as prone as privateinvestors to make mistakes, and they are prone to pegging the rate tounsustainable levels!

$owever, I would argue that with floating e%change rates firms,especially in markets approaching perfect competition, are still morevulnerable to short term shocks to floating e%change rates, forcingthem to be more conservative! In contrast, fi%ed e%change ratesmean domestic businesses know what they'll receive and pay,

leading to increased certainty! "his means they're more confident ininvesting into capital, which will increase productivity! 7owerproduction costs can then be passed onto consumers, making acountry's e%ports more competitive! China has seen great successpegging their currency to the )(, having attracted F(I inflows of89:; billion since 2;;1, which has enable them to uickly increasetheir capital stock and hence sustain high economic growth!Friedman provides no evidence that businesses and investors are #ustas certain about floating e%change rates compared to fi%ed rates!

Indeed, I would uestion whether depreciation is always an effectivesolution in reducing a current account deficit as Friedman suggests!For e%ample, &ritain has e%perienced a persistent deficit since 0111despite being under a floating e%change rate! +ne possibility for thisis &ritain's dependence upon imported goods, meaning that in theshort run where demand for imports is more inelastic, depreciationleads to an increase in the overall value, hence worsening ourbalance of payments!

"his however is only a short run e%planation as eventually importsshould become more elastic as businesses can renegotiate contracts

etc! * more long term e%planation could be that &ritain depends onimporting raw materials for production! "his means that depreciationincreased production costs for domestic firms, offsetting any gainsin competitiveness! nder this scenario the only result ofdepreciation is increased inflation within the - economy!

Instead, the &ank of England has placed a stronger emphasis uponthe - 'productivity pule', where labour productivity has been'e%ceptionally weak' post recession! "his, I would argue, is a moreimportant factor in resolving a balance of payments deficit thane%change rate systems, because if labour productivity growth falls

behind other countries, then our production costs increase relative toother countries, resulting in further losses of competitiveness!

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Finally, Friedman seems to immediately dismiss the role of tradebarriers in a successful economy! $e seems to have not consideredthat tariffs in some cases may be necessary < for e%ample, cigarettesupon consumption produce negative e%ternalities such as the harmsof passive smoking! "ariffs may have an important role ininternalising e%ternal costs, and hence reduce consumption closer to

socially optimum levels!

In conclusion, I would agree with Friedman that a floating e%changerate is the best system to use in most cases, because it removes theneed to hold foreign e%change reserves and the risks ofmismanagement by government institutions! $e seems to place toomuch emphasis upon e%change rate systems though, and not enoughupon supply side improvements < after all, without competitivedomestic producers, it is impossible to resolve balance of paymentproblems regardless of e%change rates=