What Are The Realistic Complications Of Exchange Rate System?

International trade open new investment and consumption opportunities for a country, but it also complicates the life of economic policymakers. One complication occurs because the quantitative relationships between monetary policy, the exchange rate, foreign trade, and output and prices are extremely complex, particularly at the very first link. Current economic models cannot accurately predict the impact of monetary policy changes on exchange rates.

Further, even if we knew the exact amount exchange rate relationship, the impact of exchange rates on net exports is complicated and difficult to predict. Moreover, exchange rates and trade flows will be simultaneously affected by the fiscal and monetary policies of other countries, so we cannot always disentangle the causes and effects of changes in trade flows. And the capital account may add further layers of complexity and unpredictability.

When political conditions, tax laws, or the inflation outlook change, this may attract or repel investor's funds, change the demand for a nation's assets, and affect exchange rates. On balance, confidence in our ability to determine the best timing and likely effects of monetary policies has diminished in recent years as our economy has become more open to trading and financial flows.