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Fear of Floating Needn't Imply Fixed Rates: Feasible Options for Intermediate Exchange Rate Regimes

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  • Thomas D. Willett

    (Claremont McKenna College and Claremont Graduate University)

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    Abstract

    The criteria of the theory of optimum currency areas suggest that many (most?) 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. The paper argues that the unholy trinity analysis 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. Therefore policy officials need some institutional insulation from short sighted political pressures. A problem with most intermediate regimes is that they have focused on particular forms of limited exchange rate flexibility per se, rather than the weight that should be given to the exchange rate in setting monetary policy. 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 their approach with the literature on open economy aspects of inflation targeting.

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    Bibliographic Info

    Paper provided by Claremont Colleges in its series Claremont Colleges Working Papers with number 2002-18.

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    Date of creation: May 2002
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    Handle: RePEc:clm:clmeco:2002-18

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    Keywords: political economy; capital mobility; exchange rates; discipline;

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    1. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
    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. Laurence Ball, 2000. "Policy Rules and External Shocks," NBER Working Papers 7910, National Bureau of Economic Research, Inc.
    4. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    5. Bofinger, Peter & Wollmershaeuser, Timo, 2001. "Managed Floating: Understanding the New International Monetary Order," CEPR Discussion Papers 3064, C.E.P.R. Discussion Papers.
    6. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
    7. Barry Eichengreen, 2002. "Can Emerging Markets Float? Should They Inflation Target?," Working Papers Series 36, Central Bank of Brazil, Research Department.
    8. 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, July.
    9. Willett, Thomas D & Wolf, Matthias, 1983. "The Vicious Circle Debate: Some Conceptual Distinctions," Kyklos, Wiley Blackwell, vol. 36(2), pages 231-48.
    10. Dalia Hakura & Ehsan U. Choudhri, 2001. "Exchange Rate Pass-Through to Domestic Prices," IMF Working Papers 01/194, International Monetary Fund.
    11. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
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    Cited by:
    1. Alexis Cruz-Rodriguez, 2013. "Choosing and Assessing Exchange Rate Regimes: a Survey of the Literature," Revista de Analisis Economico – Economic Analysis Review, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines, vol. 28(2), pages 37-61, October.
    2. Tony Cavoli & Ramkishen S. Rajan, 2006. "Inflation Targeting Arrangements In Asia : Exploring The Role Of The Exchange Rate," Macroeconomics Working Papers 22564, East Asian Bureau of Economic Research.
    3. Tony Cavoli & Ramkishen Rajan, 2003. "Designing Appropriate Exchange Rate Regimes for East Asia: Inflation Targeting and Monetary Policy Rules," Centre for International Economic Studies Working Papers 2003-09, University of Adelaide, Centre for International Economic Studies.
    4. Isriya Nitithanprapas & Thomas D. Willett, 2002. "Classifying Exchange Rate Regimes," Claremont Colleges Working Papers 2002-22, Claremont Colleges.
    5. corrinne ho & robert n mccauley, 2004. "Living with flexible exchange rates:," International Finance 0411003, EconWPA.

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