ABSTRACT
The string of fi nancial crises that have occurred over the last decade or so in emerging economies around the world points to the importance of stabilising the exchange rates of local currencies in the current international monetary and fi nancial environment characterised by free markets, capital account liberalisation, and an increasing regionalisation of international trade as well as capital fl ows – as is captured by gravity models that explain trade as well as foreign direct investment (FDI) mainly by geographic proximity. In this framework, as Cohen (1998, 2002) and McKinnon (2004) observe, exchange rate volatility between key currencies like the US dollar and the euro has increased signifi cantly in recent years. The same may be argued with respect to international capital fl ows, which have become more volatile, especially at the short-term end of the spectrum (see Stiglitz, 2004). Clearly, volatile capital fl ows and exchange rates are at present two major sources of fi nancial instability (and crises) to which countries not engaged in regional monetary integration are exposed. Middle Eastern and North African (MENA) countries are a case in point in this regard.
