ABSTRACT
When a country makes a lasting commitment to a policy of monetary stabilization, it is making an investment in the value of its national currency. The domestic pay-off of this investment can be the curbing of inflation, and the external pay-off can be the prevention of a foreign exchange crisis. Exchange rate movements are no longer considered necessary and irreversible adjustments. They are seen as nothing more than fleeting market signals, no matter how abrupt they are. In the 1980s, French economic policy gradually adopted the notion that the exchange rate could be used as an effective nominal anchor. By setting a nominal exchange rate target vis-à-vis a trading partner with a good record on inflation-Germany-France was able to import disinflation and enhance the synchronization of its economic cycles. This type of arrangement ought to reduce the risk of an inflation gap and help prevent foreign exchange crises. There is less chance of economic cycles getting out of synch, and the real exchange rate is brought back into line through the adjustment of domestic prices. In the case of France and Germany, this adjustment was achieved by the sharp slowdown of price inflation in France, which was one of the partners most actively seeking to meet an exchange rate target.
