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Fear of Floating Needn't Imply Fixed Rates: An OCA Approach to the Operation of Stable Intermediate Currency Regimes

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  • Thomas Willett

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    Abstract

    The criteria of the theory of optimum currency areas suggest that many countries are not good candidates for either of the poles of genuinely fixed exchange rates or freely floating exchange rates. Thus, many countries should have an interest in intermediate exchange rate regimes. However, in a world of substantial capital mobility most forms of intermediate exchange rate regimes have proven to be highly crisis prone. This essay argues that the unholy trinity paradigm doesn't imply that intermediate exchange rate regimes are inherently unstable, but rather that exchange rate and monetary policies need to be jointly determined. The difficulties of maintaining such consistency are as much political as economic since temporarily pegged or managed rates create a time inconsistency problem. It is argued that OCA theory provides the framework for determining the appropriate weights and limits on the amount of sterilized intervention to maintain the consistency between exchange rate and monetary policies necessary to avoid currency crises. The paper also considers a number of the issues involved in integrating this approach with the literature on open economy aspects of inflation targeting. Copyright Kluwer Academic Publishers 2003

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    File URL: http://hdl.handle.net/10.1023/A:1021251303089
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    Bibliographic Info

    Article provided by Springer in its journal Open Economies Review.

    Volume (Year): 14 (2003)
    Issue (Month): 1 (January)
    Pages: 71-91

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    Handle: RePEc:kap:openec:v:14:y:2003:i:1:p:71-91

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    Web page: http://www.springerlink.com/link.asp?id=100323

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    Keywords: exchange rates; unstable middle; inflation targeting; optimum currency areas;

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    1. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    2. Frankel, Jeffrey A & Rose, Andrew K, 1996. "The Endogeneity of the Optimum Currency Area Criteria," CEPR Discussion Papers 1473, C.E.P.R. Discussion Papers.
    3. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
    4. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
    5. Laurence Ball, 1998. "Policy Rules for Open Economies," NBER Working Papers 6760, National Bureau of Economic Research, Inc.
    6. Frankel, Jeffrey A. & Rose, Andrew K., 1995. "Empirical research on nominal exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 33, pages 1689-1729 Elsevier.
    7. Andrew G. Haldane & Nicoletta Batini, 1998. "Forward-Looking Rules for Monetary Policy," NBER Working Papers 6543, National Bureau of Economic Research, Inc.
    8. Bofinger, Peter & Wollmershaeuser, Timo, 2001. "Managed Floating: Understanding the New International Monetary Order," CEPR Discussion Papers 3064, C.E.P.R. Discussion Papers.
    9. Maurice Obstfeld & Kenneth Rogoff, 1995. "The Mirage of Fixed Exchange Rates," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 73-96, Fall.
    10. William H. Branson & Jacob A. Frenkel & Morris Goldstein, 1990. "International Policy Coordination and Exchange Rate Fluctuations," NBER Books, National Bureau of Economic Research, Inc, number bran90-1, April.
    11. Andrew Berg & Eduardo Borensztein, 2000. "The Choice of Exchange Rate Regime and Monetary Target in Highly Dollarized Economies," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 285-324, November.
    12. Willett, Thomas D & Wolf, Matthias, 1983. "The Vicious Circle Debate: Some Conceptual Distinctions," Kyklos, Wiley Blackwell, vol. 36(2), pages 231-48.
    13. John B. Taylor, 2001. "The Role of the Exchange Rate in Monetary-Policy Rules," American Economic Review, American Economic Association, vol. 91(2), pages 263-267, May.
    14. Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Giancarlo Marini & Giovanni Piersanti, 2012. "Models of Speculative Attacks and Crashes in International Capital Markets," CEIS Research Paper 245, Tor Vergata University, CEIS, revised 24 Jul 2012.
    2. Pierre L. Siklos & Diana N. Weymark, 2007. "Is Sterilized Intervention Effective? New International Evidence," Working Papers 142007, Hong Kong Institute for Monetary Research.

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