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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

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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  • 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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    Cited by:

    1. Piersanti, Giovanni, 2012. "The Macroeconomic Theory of Exchange Rate Crises," OUP Catalogue, Oxford University Press, number 9780199653126.
    2. Eduard Hochreiter & Pierre Siklos, 2004. "From Floating to Monetary Union: The Economic Distance between Exchange Rate Regimes," SUERF Studies, SUERF - The European Money and Finance Forum, number 2004/5 edited by Morten Balling, May.
    3. Pierre L. Siklos & Diana N. Weymark, 2007. "Is Sterilized Intervention Effective? New International Evidence," Working Papers 142007, Hong Kong Institute for Monetary Research.
    4. 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.
    5. 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.
    6. 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.
    7. 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.
    8. 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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