ABSTRACT

This chapter shows that establishing a world currency is a worthwhile long-term objective for the international monetary system. It compares fixed and flexible exchange rates mainly from two perspectives, namely, how they fare in terms of relative price adjustment at international level and, relatedly, whether they facilitate the external adjustment of trade (current account) imbalances. The chapter explains how difficult it is to evaluate benefits and costs of floating exchange rates. Flexible exchange rates are desirable as conduit of adjustment only for real shocks, not necessarily for nominal shocks. A large body of research suggests that pass-through (transmission) from exchange rates to (retail and wholesale) prices is limited and well below one, even in the long term. The chapter concludes that there are additional important elements in central banks that would also need to be addressed, for example the lender of last resort function.