02-09-2017, 12:34 PM
The selection of the exchange rate regime is one of the most fundamental political issues in macroeconomics. The range of possible options varies from the hard peg to a freely floating nominal exchange rate, with a variety of intermediate arrangements often referred to as soft pegs. The latter group of regimes includes the fixed (but adjustable) conventional exchange rate, the towing pin, an exchange rate band and a trailing band. A tracking pin is given by a pin that can gradually change over time. An exchange rate band is defined by the central bank that has been committed to a certain range for the exchange rate, while a bandwidth is a band of exchange rate that may change over time. A managed float is an exchange rate regime that lies between the soft pegs and the free float. In this case, the central bank may intervene in the foreign exchange market, but is not committed to a particular exchange rate or exchange rate. Hard pegs include coin boards and situations where a country does not have a national currency, such as in a monetary union.
There are three main reasons why a country may want to fix its exchange rate. First, a floating exchange rate can be highly volatile and difficult to predict not only in the short term, but also in the long run. Costs related to exchange rate uncertainties are difficult to quantify and differ according to factors such as the size and degree of openness of a country. Second, linking to a low inflation currency can serve as a compromise device to help contain domestic inflationary pressures. Third, for countries attempting to reduce inflation from excessive levels, fixed rates can help control the evolution of prices of traded goods and provide an anchor for inflation expectations in the private sector.
Throughout modern history we have seen a series of periods in which a fixed exchange rate has been the dominant regime. A common feature of such regimes appears to be the key role of a leading country's currency ("key currency"), such as the British pound in the 19th century and the US dollar after the Second World War (see Issing, 1965). In the late 1800s and early 1900s, the classical gold standard prevailed (see, for example, Eichengreen, 1996). After its political unification in 1871, Germany, adopting the British example, followed a gold standard and a great number of European countries, as well as of countries of South and South America followed its example, thus creating a system of exchange rates fixed costs of transportation of gold). However, the first negotiated system of fixed exchange rates was the Bretton Woods system. In contrast to the classical gold standard, the Bretton Woods agreement initially implied strict limits on the mobility of capital and the price of the national currency was set against the US dollar (gold respectively). This arrangement dominated the international monetary system from its introduction after World War II until its final collapse in 1973.
After the breakup of the Bretton Woods system, most countries in a series of measures have dismantled their still existing capital controls. In Europe we have seen a number of attempts to create a fixed exchange rate agreement, such as the so-called "Snake" and later the Mechanism of Change (MTC) of the European Monetary System (EMS). However, following major speculative attacks against several currencies in the early 1990s, some European countries, such as Sweden and the United Kingdom, opted for a different regime and allowed their exchange rate to float. Other countries preferred to remain within the ERM with the aim of forming a monetary union in Europe.
Classifying exchange rate regimes is not always easy in practice. What the authorities say (de jure) and what they actually do (de facto) sometimes differs considerably. On the other hand, there were sometimes parallel and dual exchange rates markets, further complicating de facto classification. Fischer (2001) presents some evidence on the development of de facto exchange rate regimes for IMF member countries in 1991 and 1999. Given the IMF's assessments of de facto regimes, 38 percent of countries had a fixed rate or a floating exchange rate in 1991, while 62 percent had various types of soft arrangements. In 1999, the situation had essentially been reversed when 66 per cent of countries had a fixed rate or a floating exchange rate, while only 34 per cent had a soft peg arrangement.
There are three main reasons why a country may want to fix its exchange rate. First, a floating exchange rate can be highly volatile and difficult to predict not only in the short term, but also in the long run. Costs related to exchange rate uncertainties are difficult to quantify and differ according to factors such as the size and degree of openness of a country. Second, linking to a low inflation currency can serve as a compromise device to help contain domestic inflationary pressures. Third, for countries attempting to reduce inflation from excessive levels, fixed rates can help control the evolution of prices of traded goods and provide an anchor for inflation expectations in the private sector.
Throughout modern history we have seen a series of periods in which a fixed exchange rate has been the dominant regime. A common feature of such regimes appears to be the key role of a leading country's currency ("key currency"), such as the British pound in the 19th century and the US dollar after the Second World War (see Issing, 1965). In the late 1800s and early 1900s, the classical gold standard prevailed (see, for example, Eichengreen, 1996). After its political unification in 1871, Germany, adopting the British example, followed a gold standard and a great number of European countries, as well as of countries of South and South America followed its example, thus creating a system of exchange rates fixed costs of transportation of gold). However, the first negotiated system of fixed exchange rates was the Bretton Woods system. In contrast to the classical gold standard, the Bretton Woods agreement initially implied strict limits on the mobility of capital and the price of the national currency was set against the US dollar (gold respectively). This arrangement dominated the international monetary system from its introduction after World War II until its final collapse in 1973.
After the breakup of the Bretton Woods system, most countries in a series of measures have dismantled their still existing capital controls. In Europe we have seen a number of attempts to create a fixed exchange rate agreement, such as the so-called "Snake" and later the Mechanism of Change (MTC) of the European Monetary System (EMS). However, following major speculative attacks against several currencies in the early 1990s, some European countries, such as Sweden and the United Kingdom, opted for a different regime and allowed their exchange rate to float. Other countries preferred to remain within the ERM with the aim of forming a monetary union in Europe.
Classifying exchange rate regimes is not always easy in practice. What the authorities say (de jure) and what they actually do (de facto) sometimes differs considerably. On the other hand, there were sometimes parallel and dual exchange rates markets, further complicating de facto classification. Fischer (2001) presents some evidence on the development of de facto exchange rate regimes for IMF member countries in 1991 and 1999. Given the IMF's assessments of de facto regimes, 38 percent of countries had a fixed rate or a floating exchange rate in 1991, while 62 percent had various types of soft arrangements. In 1999, the situation had essentially been reversed when 66 per cent of countries had a fixed rate or a floating exchange rate, while only 34 per cent had a soft peg arrangement.