Some of the definitions of financial stability include the notion that economic actors can operate without fear of disruption, of financial instability, being a material factor in their decisions, William A. Allen and Geoffrey Wood, “Defining and achieving financial stability”, Journal of Financial Stability, Vol. 2, 2006, 152, 160.
Therefore, the flexible exchange rate doesn’t absorb the commodity price shock as much as it helps the economy adjust more easily to the shock by smoothing the adjustment in relative prices.14 This relatively smooth adjustment is in stark contrast to the counterfactual exercise where the relative price adjustment occurred from a sharp fall in output, a pronounced rise in unemployment and lower wages and prices.