Foreign exchange market if the exchange rate is to be stabilized

There are several means by which this can be achieved. The main ones are:

Use of reserves. The most desirable means of pegging an exchange rate is to manipulate the market

through the use of official reserves. This is not a problem if deficits and surpluses occur more or

Less randomly and are of approximately equivalent size. But if a nation encounters persistent and

Sizable deficits for an extended period of time, the reserves problem can become critical and force the

Abandonment of a system of fixed exchange rates. Or, at least, a nation whose reserves are inadequate

Must resort to less appealing options if it hopes to maintain exchange rate stability.

Trade policies. One set of policy options entails measures designed to control directly the flows

Of trade and finance. Specifically, imports can be reduced by imposing tariffs or import quotas.

The fundamental problem with these policies is that they reduce the volume of world trade and

Distort its composition or pattern away from that which is economically desirable. That is, tariffs,

Quotas, and the like can be imposed only at the sacrifice of some portion of the economic gains or

Benefits attainable from a free flow of world trade based upon the principle of comparative advantage.