It is natural that a country that industrializes will also begin to liberalize its goods and financial markets. As it seeks to move more fully into the international community of industrialized countries, it will be called upon to allow ever more aspects of its economy to be determined in the marketplace rather than by the government. But it does not follow that every aspect, every macroeconomic variable, should be determined by the marketplace. To focus on a clear example, the exchange rate should not necessarily be determined in the marketplace. Letting the exchange rate float makes more sense if the monetary authorities have decided to fix the money supply (or other nominal quantity). But an equally admissible alternative plan is to fix the exchange rate and let the money supply do the adjusting. One must choose among equally plausible regimes.

To make this point is not to knock down a “straw man.” The U.S. Treasury has in recent years advised newly industrialized countries (NICs) in East Asia that free-market principles necessarily imply free-floating exchange rates. Free-marketeers Milton Friedman and Beryl Sprinkel might agree with that choice, but free-marketeers Robert Mundell and Jack Kemp would not.

Democracy, discipline and deficits

This chapter reviews choices among regimes facing a relatively small, trade-oriented, liberalizing, industrializing country. We begin by observing that the problem is neither interesting nor realistic unless due allowance is made for market failures, such as sticky prices, as well as political failures, such as populist spending binges.