With the nominal exchange rate held down by intervention, this could only come about through a rise in prices, creating expectations of future inflation and so reducing real interest rates.

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Argentina is yet another country which has exchanged instability in its nominal economy, with a floating exchange rate, for instability in its real economy with a fixed exchange rate.

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It would oblige Argentina to continue trying to adjust its real exchange rate by deflation (cutting nominal wages and prices in nominal terms), a process which has already forced the collapse of many businesses.

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The fundamental difference is that under a fixed exchange rate real income declines must come through nominal income declines.

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However, an increase in the real exchange rate need not require a rise in the nominal rate.

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If the trade imbalance is sterilized and not allowed to affect the exchange rate, then there will be upward pressure on foreign prices and nominal incomes and downward pressure on U.S. prices and nominal incomes.

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