Exchange rate policy

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Exchange rate policy

The first papers deals with

Exchange rates and the choice of monetary policy regimes -Fewer

monies better monies,by Rudi Dornbusch.




A century ago gold was the standard for civilization.Gradually this had

become international and countries if they were not on gold,at least

they were on sterling or the dollar.After world war one all that fell

apart in the great depression with capital controls,devaluation and

discretionary central banking.

Exchange rates and the choice of monetary policies.

After the great inflation of the 170s,extreme monetary experiences in

most developing nations,the past 0 years have changed monetary

management fundamentally.Emerging economic trend is for

independent central banks with transparency and some inflation

target.Emerging trend is also towards monetary integration.In Europe

they have got the EMU.

In Americas progress on monetary integration is far more

haphazard.Europe and Americas independence makes political

integration an uninteresting issue.A national currency as opposed to a

hard dollar peg,is seen as an unquestioned plus for reasons to be

discovered.

In Asia the discussion of monetary arrangements is picking up at the



(1)

behest of Japan.

(Eiji Ogawa and Takatoshi Ito, 000).



Arguments against currency board arrangements

1.Sovereignty is beyond discussion because of the quality of money

and the emerging economies.

.As far as loss of seigniorage is a critical issue for public finance but

any kind of stability-oriented monetary policy will yield some bonous

but currency boards and dollarization presumably commands the

highest bonus.

.As far as the monetary policy is concerned,the external balance not

the local central bank will determine interest rates so this issue has

very little imporatance.

4.There is a concern about loss of the leader of last resort.

5.Another argument in questioning currency boards is fiscal

preparedness.How a discretionary monetary and exchange rate policy

can accomodate a bad fiscal situation better than a fixed rate.The

savings on debt service from lower interest rate under a currency board

should compensate for the loss of seignorage.

Exchange rate issue

Author argues that disturbance in price levels due to fixed exchange

rate could be tackled by financing.

For relative price adjustments partial adjustment of consumption or

()

investment and current account financing should be most of the

buffer.There should be a flexibility of wages and prices.Author argues

that if anything exchange rates have been the dominant instrument of

destabilization.

Author favours the monetary policy regimes and fixed exchange rates

says that gains come in two forms

1.There is a dramatic decline in interest rates with all attendant

benefits(Francesco Giavazzi and Marc Pagano 188).In case of Greece

and Italy becoming part of EMU the gains were striking and some for

Argentina.

.Transformation of the financial sector and the lengthening of agents

horizons.With low inflation and stable inflation and a stable

currency,economic horizons lengthen,which is conducive to

investment and risk taking which translates in to growth.

Once the economy stabilizes distortions and inefficiencies become far

more apparent and can be targates.

Hence a monetary regime that delivers and mantains low inflation

other things equal will help growth.

Author argues that much talked about case of Argentina as an example

of failure of currency board.The reasons were

1.Argentina has a very high level of debt and very poor fiscal situation.

.Argentina has invested little,economy obsolete,closed.

()

.Legacy of labour relations,unions.

Author says that Mexico is a good candidate for currency board most

trade is with U.S,NAFTA.

.Second article is on A Reconsideration of the twentieth century by

R.A Mundell.Author discusses role of the monetary factor as a

determinant of political events.He argues that many of the political

changes inthe century(which he calls as American Century)have been

caused by little understood perturbances in the international monetary

system,while there in turn have been a consequence of the rise of the

U.S and mistake of its financial arm the Federal Reserve system.

The Author argues that the flexible exchange rates did not provide the

same discipline as the fixed rates.The cost of inflation are much higher

in a world with progressive income tax rates.And a need for and

means of attaining monetary stability can be learned.It is also said that

the policy mix can shift the Phillip curve.Author state that experience

breeds its own reaction as Plato the inflationist gave birth to

Aristotlo,the hard money man.

The reaction in the 180s gave a boost to central bank

independence.Governments had to cut back on spending growth as

well as deficits.

Authors establish that flexible exchange rates are an unnecessary evil

(4)

in a world where each country has achieved price stability.

The main points come out of this article are

¡¤ International monetary system depends on the power

configuration of the countries that make it up.

¡¤ Despite the incredible rise in gold production,Greshams law

came in to play and the dollar elbowed out gold as the principal

international money.

¡¤ In the first third of the twentiethcentury there was a

confrontation of the Federal Reserve System and standard of

gold.

¡¤ The gold standard was broken down in World War1 restored in

10s and created deflation in 10s.The great depression led

to totalitarianism and World War .

¡¤ Second third of the twentieth century was dominated by the

contradiction between national macroeconomics and its

management and new international monetary syatem.U.S fixed

the price of gold and different countries fixed their curriencies

to the convertible dollar 170s U.S stopped fixing price of

gold and other countries stopped fixing the price of dollar.

¡¤ 10 started with the search of new international monetary

architecture.



(5)



Today they talk about stability,fiscal prudence and inflation

control.

¡¤ The dollar,the euro and the yen have established.

¡¤ Things to be corrected are exchange rate volatility and the

absence of international currency.

For inflation and unemployment to control,cuts in marginal tax rates

were needed,tight money would produce price stability.

The third article is on The care for flexible exchange rates.

Author argues that in current economic and political conditions

flexible exchange rates suit more.He says that

1.these conditions make a system of flexible or floating exchange rate

which are freely determined in an open market primarily by private

dealings and like other market prices varying from day to day.

.The achievement and maintenance of a free and prosperous world

community with unrestricted multilateeral trade.

.There is no facet of international economic policy for which the

acceptance of a system of rigid exchange rates does not create serious

problems.

4.Promotion of rearmament ,liberalization of trade,avoidance of

allocations and other direct control,harmonization of internal monetary

and fiscal policies there problems become easier to solve in a world of

(6)

flexible exchange rates and its corollary free convertibility of

currencies.

5.Unrestricted multilateral trade will become a real possibility with

flexible exchange rates.

According to the author instability of exchange rates ia a sympton of

instability in the economic structure.Unrestricted multilateral trade

means no direct quantitative controls over imports and exports.

Author suggests alternative methods of adjusting to changes affecting

international payments.

1.Countrays currency may bid up or put up in price.This will make

currency less desirable relative to the currency of other countries and

thus eliminate the excess demand at preexisting rate.

.Prices within country may rise and thus goods demand within the

country less desirable relative to goods in other countries.



.Direct control over transactions.

4.Excess amount of domestic currency may be provided out of

monetary reserves.

He further argues that changes in the exchange rates may be used to

maintain equilibrium in the balance of payments through

1.flexible exchange rates.

.official changes in rigid rates.

(7)

If Germany had a flexible exchange rate in 150 it would have not

created such a crisis as Germany faced.He further gives the example of

U.K.

He concludes that changes in temporarily rigid exchange rates neither

provide stability nor the continuous sensitivity of a flexible exchange

rate.

While discussing internal prices or income author says that if the

internal prices are as flexible as exchange rates then it would make

little economic differences.Wage rates tend to be among the less

flexible prices.

Direct control on imports,exports and capital movements could bring

about the same effect on trade and the balance as changes in exchange

rates.However the direct controls have a tendency to make the

incentive to export lower than it would otherwise be.

Monetary reserves must be used for to retire debt or to finance a deficit

in the budget to prevent price decline.

He states that flexible exchange rate is the best device suitable for

current conditions as use of reserve is not a feasable device,direct

control are inefficient,changes in internal prices and income are

undesirable.

There are three najor objectives to flexible exchange rates

1.flexible rates increase the degree of uncertainty.

(8)

.make it impossible for exporters and importers to be certain about

the price they will have to pay or receive in foreign exchange.

.speculation in foreign exchange markets tend to be destabilizing.

He argues that there is nothing essential in EPU that would be an

obstacle to flexible exchange rates.Same comments apply to

international monetary funds.

A fixed price for gold can be maintained in one country without

interfering with flexible exchange rates.U.S now has such fixed

price.Gold is a highly safe means of keeping liquid reserve so there

should be a free gold market.

As far as sterling area is concerned,flexible exchange rates could be

instituted within the sterling area and aterling and other currencies or

fixed exchange rates could be retained within the sterling area.

Flexible exchange rates would help in

1.Unrestricted multilateral trade.

.The hormonization of internal monetary and fiscal policies.

.The rearmament drive.

Countries separately or jointly establish a system of exchange rates

freely determined in open market by private transactions,abandonment

of direct controls over echange transactions.This move is a basic

requirement for the economic integration of the free world through

()

multilateral trade.

Emerging trend is towards monetary integration.EMU has given

enough impact on to this.NAFTA is also forwarding towards the

integration.In asia the discussion of monetary arrangements is picking

up.Fixed exchange rate provide decline in interest

rates,inflation,stability,trade and economic upliftment.The dollar,the

euro and the yen have established as three monetary stability

islands.Efforts are moving towards an international currency and fixed

exchange rates.



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