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The Flexible Exchange Rate System: Experience and Alternatives

  • Dornbusch, Rudiger
  • Frankel, Jeffrey

We review ten aspects of how floating exchange rates have worked in practice, contrasted with ten characteristics that the system was supposed to have in theory. We conclude that the foreign exchange market is characterized by high transactions-volume, short-term horizons, and an absence of stabilizing speculation. As a result, the exchange rate at times strays from the equilibrium level dictated by fundamentals, contrary to theory. We then look at ten proposed alternatives to the current system. Four entail decentralized policy rules: new classical macroeconomics, a gold standard, monetarism, and nominal income targeting. Four foresee enhanced international coordination: G-7 "objective indicators," Williamson target zones, McKinnon "world monetarism," and a "Hosomi Fund." Two propose enhanced independence: a "Tobin tax" on transactions, and a dual exchange rate. We conclude that one might build a case for intervention from the observed failure of international financial markets to behave as in the theoretical ideal, but that government intervention in practice is just as likely to fall short of the theoretical ideal

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Paper provided by Department of Economics, Institute for Business and Economic Research, UC Berkeley in its series Department of Economics, Working Paper Series with number qt5ct1w459.

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Date of creation: 14 Feb 1988
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Handle: RePEc:cdl:econwp:qt5ct1w459
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