chapter  9
18 Pages

Exchange rate policy

The case for exchange-rate stabilisation Chapter 4 explained that one of the basic tenets of the 1990s synthesis was attachment to free floating for key currencies: exchange rates between the main trading currencies must be free to vary if industrialised economies are to cope with divergent productivity trends and external shocks, given the limited real wage and price flexibility that many of them still display. However, Chapter 5 argued that the large and persistent fluctuations seen in major currencies since the start of generalised floating in the early 1970s have created serious problems for industry in open trading economies. Experience over many years suggests that persistent real exchangerate swings cause substantial resource misallocation and structural distortion in economies with large exposure to foreign trade. The consequences for industry are long lasting and hard to reverse, and over time they outweigh the advantages from floating, which in many cases merely shift the burdens of adjustment between different countries while not reducing them overall. Moreover currency floating often conceals weaknesses in monetary and fiscal policies, and these would be better addressed on the cooperative lines proposed in Chapters 7 and 8.