ABSTRACT

Introduction Since the break-up of Bretton Woods, currency volatility has increased. Its effects on an economy can be devastating, as uncertainty makes investment decisions almost impossible. This is one of the main justifications for the move towards EMU as many European countries have suffered due to this currency volatility. Given large speculative capital flows, the exchange rate regimes which seem most durable are floating exchange rates and monetary unification (the two ends of the spectrum). Intermediate regimes which involve explicit exchange rate targets (pegged but adjustable rates, target zones, currency bands, crawling pegs) invite attack and perform well for only short periods. Given this, one can assume that countries will in the long term tend to one end of the currency spectrum or the other. It seems likely that large countries like the US, Japan and Germany will continue to float one against the other, whereas smaller countries will seek to establish fixed rates with their larger trading partner. This implies that we are moving towards a world of three currency zones: the dollar, yen and EMU. Though the process will be a slow one, its roots are already very much in place.