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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

Suggested Citation

  • Thomas Willett, 2003. "Fear of Floating Needn't Imply Fixed Rates: An OCA Approach to the Operation of Stable Intermediate Currency Regimes," Open Economies Review, Springer, vol. 14(1), pages 71-91, January.
  • Handle: RePEc:kap:openec:v:14:y:2003:i:1:p:71-91
    DOI: 10.1023/A:1021251303089
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    References listed on IDEAS

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    1. Frankel, Jeffrey A & Rose, Andrew K, 1998. "The Endogeneity of the Optimum Currency Area Criteria," Economic Journal, Royal Economic Society, vol. 108(449), pages 1009-1025, July.
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    7. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, January.
    8. Choudhri, Ehsan U. & Hakura, Dalia S., 2006. "Exchange rate pass-through to domestic prices: Does the inflationary environment matter?," Journal of International Money and Finance, Elsevier, vol. 25(4), pages 614-639, June.
    9. Barry Eichengreen, 2006. "Can Emerging Markets Float? Should They Inflation Target?," Chapters,in: Monetary Integration and Dollarization, chapter 8 Edward Elgar Publishing.
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    11. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
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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. Aizenman, Joshua & Ito, Hiro, 2014. "Living with the trilemma constraint: Relative trilemma policy divergence, crises, and output losses for developing countries," Journal of International Money and Finance, Elsevier, vol. 49(PA), pages 28-51.
    3. Joshua Aizenman & Hiro Ito, 2014. "The More Divergent, the Better? Lessons on Trilemma Policies and Crises for Asia," Asian Development Review, MIT Press, vol. 31(2), pages 21-54, September.
    4. Pierre L. Siklos & Diana N. Weymark, 2007. "Is Sterilized Intervention Effective? New International Evidence," Working Papers 142007, Hong Kong Institute for Monetary Research.
    5. Thomas D. Willett & Ekniti Nitithanprapas & Isriya Nitithanprapas & Sunil Rongala, 2004. "The Asian Crises Reexamined," Asian Economic Papers, MIT Press, vol. 3(3), pages 32-87.
    6. Ball, Christopher P. & Reyes, Javier, 2008. "Inflation targeting or fear of floating in disguise? A broader perspective," Journal of Macroeconomics, Elsevier, vol. 30(1), pages 308-326, March.

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