The preceding review and analysis of a decade of experience with managed floating is suggestive of some ways to improve the operation of the exchange rate system. In this section, that theme is expanded upon by considering some directions for possible restructuring of the exchange rate system. It should be emphasized that at this early stage of the debate, the purpose is not to draw firm conclusions about the best single proposal, but rather to offer a focus for analysis and further discussion on how the evolution of the exchange rate system might best be managed.
Rather than present an exhaustive taxonomy either of alternative exchange rate systems or specific proposals for change, this section is organized around a series of key issues for discussion. Each of these issues concerns a general channel or mechanism for altering the operation of the present system. As implied in Section II, however, such a list would probably be a sterile one without three ingredients: (1) a notion of what the objectives of these alterations should be; (2) at least a rough outline of the environment in which such a changed exchange rate system would likely have to operate; and (3) an indication of which countries or country groups would be the primary initiators or beneficiaries of these changes.
There are, of course, no simple or completely satisfactory answers to any of these three questions. For the purposes of this paper, however, it may be sufficient to employ three working assumptions that are consistent with the preceding analysis of the present system. The first such assumption is that a reasonable intermediate objective would be to maintain enough flexibility in real exchange rates to foster external adjustment, but at the same time, create conditions under which real exchange rates do not stray so far, so often, and so long from levels consistent with “fundamentals.”108 In capsule, the first part of that objective might be considered as the present system’s principal strength and the latter part, its principal weakness. Turning to the environment, perhaps the safest assumption to make is that the rest of the 1980s may be somewhat more hospitable than the 1973–82 period. This means that the exchange rate system may still have to contend, inter alia, with large disturbances of both a real and monetary variety, high international mobility of capital, unexpected demand shifts among alternative reserve currency assets, varying degrees of real wage flexibility across countries, large shifts in comparative advantage across countries, and serious sectoral problems that give rise to continuing demands for protection against foreign producers.
On the other hand, the mean rate of inflation, as well as its dispersion across countries, could well be lower, and there may continue to be a reservoir of goodwill that can be tapped for efforts aimed at greater coordination of policies.
Finally, although many channels for improving the operation of the system apply equally well to all country groups (e.g., the pursuit of stable, credible, and balanced underlying policies), it is probably most realistic to assume that initial efforts be directed primarily at the major industrial countries. As noted in Section II, most of the developing countries as well as some of the smaller industrial countries have already adopted some form of pegged exchange rates or limited flexibility in their exchange arrangements. As such, quite apart from the dominant role that the larger industrial countries play in international trade, more stability in the exchange rates of the major currencies would go a long way toward providing greater stability in the real effective exchange rates of the rest of the world.
Key Issues
With this rough outline of objectives, environment, and major participants in mind, it is possible to make an assessment of how the present exchange rate system might be altered in desirable and feasible directions. To aid in such an assessment, six key issues have been selected. The statement of each of those issues is accompanied by a brief commentary that sets forth some of the principal factors or arguments that bear on that issue. Many of these key issues are, of course, familiar from earlier reform deliberations, including those conducted under the auspices of the Committee of Twenty.
Issue No. 1
Is it reasonable to envisage the return of conditions under which fixity of exchange rates among the major currencies could be restored?
Commentary. A negative answer to this question rests on the following grounds: (1) that these countries would be unwilling to completely subordinate monetary policy to the dictates of a fixed exchange rate; (2) that structural differences among them are large enough to preclude the emergence of a common rate of inflation; (3) that there will be a need for real exchange rate adjustments to reflect changes in comparative advantage; (4) that prices and wages are too inflexible (particularly downward) to obtain the requisite real exchange rate movements without changes in nominal exchange rates; and (5) that there is no willing or readily acceptable candidate for the central role of the pivot or nth currency in the system. The case for a positive answer is essentially that: (1) there is already in prospect a significant convergence of inflation rates for the four largest countries in 1983–84; (2) the discipline necessary for coordination of policies among the others will be given great impetus by the establishment of fixed rates; (3) the policy autonomy under alternative systems is largely illusory; and (4) even a partial success (infrequently adjustable rates) would have a strong positive effect on domestic stability and the resumption of world trade growth.
Issue No. 2
If nominal exchange rates need to be adjusted to reflect changes in the “fundamentals” over time, is there any rule or formula that could help in determining the right structure of rates? Also, what about the merits of presumptive indicators for initiating adjustment?
Commentary. The principal argument against the use of formulas or rules for determining appropriate changes in nominal exchange rates (e.g., a crawling peg based on inflation differentials or on an average of past exchange rate movements) is that the factors calling for exchange rate changes (for example, shifts in labor productivity, permanent changes in the terms of trade, changes in tastes, natural resource discoveries, dramatic changes in expected future macroeconomic policies, etc.) or symptoms of an exchange rate maladjustment (for example, heavy capital inflows and attendant excessive indebtedness and intensifying exchange controls) are too varied, too unpredictable, and too unstable over time to be captured ex ante in any formula or rule. There is also the supplementary argument that while such a formula approach may have represented a reasonable second-best solution to the nominal exchange rate rigidities of the Bretton Woods era, this approach loses its raison d’être in today’s world where exchange rates are, if anything, too flexible. The main counterargument is perhaps that exchange rate formulas represent a reasonable middle ground between the excessive rigidity of administratively set exchange rates and the excessive volatility of market-determined rates. Furthermore, its supporters might also point out that market-based forecasts of exchange rates (e.g., forward exchange rates) have themselves proved to be very poor predictors of actual exchange rates, so that the uncertainty problem is not specific to formulas or to rules.
“Presumptive” or “objective” indicators for adjustment are less restrictive in principle because they only signal a need for adjustment but usually do not specify the combination of adjustment measures that the country should adopt. In brief, the case for them is that the regular examination of a set of multiple indicators could help to detect problems at an early stage and hence induce a more timely and more symmetrical pattern of adjustment than would occur in their absence (or at least trigger discussions of policy among countries that make coordinated surveillance workable). As with exchange rate rules, opposition to them is often based on the arguments that there is no simple indicator that will consistently transmit reliable adjustment signals and that, even if there were such an indicator, practical problems over its precise definition, measurement, and monitoring would severely limit its applicability.
It will be recalled that an objective indicator based on international reserves was a part of the Committee of Twenty’s Outline of Reform. The only exchange rate arrangement that has actually implemented a presumptive indicator is the European Monetary System (EMS). In that system, once a country’s actual exchange rate crosses a threshold of divergence from its European currency unit (ECU) central rate, it is presumed that the authorities will undertake corrective measures (e.g., diversified intervention, domestic monetary policy measures, or changes in central exchange rates). More recently, a number of economists have proposed using the movement of exchange rates as a presumptive indicator for changes in domestic monetary policy.
Issue No. 3
Would adjustable par values with narrow margins be viable for the major currency countries in today’s world of high capital mobility?
Commentary. Although similar in many respects to the first issue (i.e., the restoration of fixed exchange rates), the capital mobility issue is given special prominence here because it is widely cited as perhaps the key contributory factor to the breakdown of the Bretton Woods system. Indeed, the case against a return to adjustable par values with narrow margins is that none of the factors that made the Bretton Woods system so vulnerable to “hot money” flows would be less problematical today or tomorrow. That is to say, large and suddenly changing interest rate differentials would still arise because of the failure to harmonize monetary and fiscal policies across countries, there would be rumors of imminent parity changes due to a whole host of circumstances (e.g., changes in governments with different economic priorities), and the resources of central banks would be insufficient to cope with the larger resources of private speculators. Some would go further and say that today’s situation would be even more tenuous than under the Bretton Woods system because liberalization measures and technological advances have combined to render capital much more mobile than during the 1950s and 1960s. Hence, if such an adjustable peg scheme could work at all, it would need both wider margins and some mechanism to insure prompt adjustment of par values. The opposing view does not so much hold that these afore-mentioned problems are less serious today than in earlier times but rather that the intractability of the problem is exaggerated. The viability of the EMS, despite its short tenure, may provide some support for this view. Specifically, if there are sufficient political commitment, generous support facilities for riding out balance of payments difficulties, active exchange market intervention policies, a presumptive indicator for adjustment, and the acceptance of the need for occasional, and sometimes occasionally large, realignments of central rates, then such a system can function, even with relatively narrow margins.
Issue No. 4
Is a solution to excessive exchange rate variability to be found in new taxes or restrictions on international capital flows?
Commentary. This is again a familiar issue but one that has gained new relevance in the debate of how to cope with overshooting of floating rates. The case against throwing “sand in the wheels” of the international capital market includes the following arguments: (1) no strong presumption exists that the resource allocation costs from impeding the international flow of capital would be less serious than those emanating from restrictions on goods; (2) there is no reliable (ex ante) method of separating “productive” from “nonproductive” capital flows by reference to such factors as maturity (short term versus long term) or ownership (portfolio versus direct investment); (3) any tax on capital flows would make it more difficult for a country to finance a current account imbalance because it would have to raise interest rates enough not only to create a favorable interest rate differential but also to offset the cost of the tax; (4) even aggressive control programs, such as those of the early 1970s, often failed to stem private capital flows, and the subsequent development of offshore banking markets makes their efficacy today less likely; and (5) unless uniform restrictions or taxes could be negotiated and accepted by all parties, there would be a constant danger of escalation and retaliation, with damaging spillovers for other international transactions. The case for such impediments to capital flows does not deny these costs; instead, it argues only that they will be smaller than the macroeconomic costs associated with larger exchange rate fluctuations under free mobility of capital.
Issue No. 5
Should greater stability of floating exchange rates be sought primarily in greater stability of macroeconomic policies at the national level and in greater coordination of these and of other policies (e.g., exchange market intervention) across countries?
Commentary. As emphasized earlier, it is by now widely accepted that floating exchange rates would show less volatility if a firmer anchor could be established for medium-term and long-term private sector expectations about exchange rates. The case for stressing the implementation of stable, credible, and balanced policies is simply that, quite apart from their favorable impact on domestic economic objectives, these policies are the single most important ingredient in generating such a stable anchor for exchange rate expectations. For, if market participants cannot gauge the medium-term course of basic policies and if they cannot be confident that basic economic objectives can be reconciled across countries without either dramatic shifts in policy mixes and/or in exchange rates, they will have little basis from which to “form a view” about future exchange rates. In such circumstances, speculative “bubbles” and “bandwagon” effects become more prevalent because there are no natural bounds for the expectations of speculators. Conversely, where countries have a history of stable policy behavior and where, therefore, forecasts of policy intentions have credibility, neither minor shocks nor short-term deviations of policies from targets are likely to be translated into large exchange rate movements because longer-term expectations about rates will not be much affected. The relative stability of the floating Canadian dollar over the 1950–61 period is often cited as an example of such a stabilizing anchor at work (i.e., the belief that a dollar should be worth approximately a dollar). Because better conduct is widely recognized as improving the functioning of any exchange rate regime, no case can be made against better macroeconomic policies. But there are doubts and questions about if and how such improved policy conduct can be brought about within the present system.
In thinking about this issue, it may also be useful to consider the following questions:
(1) What characteristics of policy behavior in the major currency countries could have been responsible for observed exchange rate behavior over the past two to three years?
(2) Have the external adjustment problems of the past decade been primarily due to a lack of agreement on appropriate policies across countries or rather to the absence of political will to implement such appropriate policies?
(3) What role should exchange market intervention play in communicating policy intentions to the market and in otherwise trying to establish an anchor for exchange rate expectations?
(4) What can be done in labor and product markets to increase the flexibility of wages and prices so that financial market prices do not have to carry so much of the burden of responding to disturbances?
Issue No. 6
Would official forecasts or target zones for exchange rates help both to reduce the variability of exchange rates and to increase the incentives for external adjustment?
Commentary. The case for official forecasts or target zones rests on two arguments. First, in the absence of such official forecasts, it is too difficult for market participants to form a view about future exchange rates. Even where policies are relatively stable, there are just too many factors operating on exchange rates to make a firm judgment about the value of the exchange rate 6 or 18 months ahead. Official forecasts of the exchange rate, provided that they are credible, are thus deemed to be necessary for generating an anchor for exchange rate expectations. Second, because the authorities would be under some pressure either to keep actual exchange rates within the target or forecast zone or to explain departures from the zone, it is claimed that the speed of external adjustment would be increased. It is argued that without such official forecasts, authorities have insufficient incentives for adjustment since they can always equate the “right” rate with the market rate.
The idea of official forecasts or target zones differs from the traditional adjustable peg system in three principal respects. First, a country’s intervention and monetary policy obligations are considerably looser under the former than under the latter. Specifically, the country does not have to intervene in the exchange market to keep its forecast rate within the prescribed zone (so-called soft margins) and it similarly does not have to make exchange rate considerations paramount in setting its monetary policy. Instead, it should not use intervention to push the actual rate away from the forecast rate when the former is outside the zone,109 and it pledges to give exchange rate considerations more attention than under the present system in formulating monetary policy.110 A second difference is that the forecast or target zones are usually contemplated as being much wider than under the adjustable peg system; those wide zones are to reflect the large margin of error associated with attempting to forecast the equilibrium exchange rate and are to provide some buffer against large and sudden capital flows. Third, the forecast rate and the zone are expected to be examined, and if necessary, altered at frequent intervals to reflect changes in countries’ comparative advantage or relative competitive positions. Because of this feature, it is possible that in some situations departures of actual exchange rates from target zones would be accommodated by changes in the target zone rather than by policy measures designed to move actual rates back into the zone.
To some observers, the practice of announcing official forecasts or targets for the growth rates of monetary aggregates in a domestic context provides a useful analogy. Such forecasts or targets provide a presumption that the authorities will conduct policies so that the growth rates of aggregates would evolve within ranges specified. In the event that the targeted aggregate should move outside its expected range, it is presumed that the authorities will act to offset this movement or will explain why the earlier target is no longer appropriate. Moreover, in many countries more than one aggregate is targeted and when, as is often the case, the different aggregates behave differently, again it is presumed that the authorities will explain their emphasis on one aggregate or another in current circumstances. Even when the explicit quantitative targets are not always attained, it is argued that they provide an anchor for expectations and a relatively straightforward context for explaining the authorities’ actions.
The case against official forecasts of exchange rates is that: (1) in a world of stable underlying macroeconomic policies, no additional anchor is needed for exchange rate expectations; (2) knowledge of the determinants of exchange rate movements, or of the equilibrium exchange rate, is so rudimentary that the target zones would have to be too wide to have value as an anchor for expectations; (3) negotiation of forecast rates, zones, and changes in them would be subject to all the centralized management delays of the Bretton Woods era, thereby robbing the scheme of its flexibility; (4) the best guide for domestic monetary policy is still that of achieving price stability; in contrast, the exchange rate can often give false signals; and (5) forecast rates or zones would only have credibility if they were backed by broad coordination of macroeconomic policies—and if such coordination could be achieved—no change in the present system would be necessary.
Statistical Tables
Exchange Rate Arrangements, June 30, 19831
No current information is available relating to Democratic Kampuchea. All members whose currencies are pegged to a single currency do so at present within zero fluctation margins. Members whose currencies are pegged to the SDR or “Other composite” maintain their exchange rates within zero or very narrow margins, seldom exceeding ±1 percent about the peg. Within the “Flexibility Limited” category, the “Single currency” subcategory lists those members that are observed to maintain an exchange arrangement such that their exchange rate fluctuates with a variability equivalent to 2¼ percent margins with respect to another member’s currency. The subclassification, “Cooperative arrangements,” lists the countries participating in the European Monetary System (EMS). With the exception of Italy, which maintains margins of 6 percent, these countries maintain 2¼ percent margins with respect to their cross rates based on the central rates expressed in terms of the European currency unit (ECU). Members with exchange arrangements listed under the “More Flexible” category are divided on the basis of the extent to which the authorities intervene in the setting of exchange rates. In some instances the exchange rate is allowed to move continuously over time; if the authorities intervene at all they do so only to influence, but not to neutralize, the speed of exchange rate movement. That exchange arrangement is classified as “Independently floating.” Alternatively, the exchange rate may be set for a short interval, usually one day to one week, and the authorities stand ready to buy and sell foreign exchange at the specified rate (the “managed floating” group).
All exchange rates have shown limited flexibility vis-à-vis the U.S. dollar.
Member maintains dual exchange markets involving multiple exchange arrangements. The arrangement shown is that maintained in the major market.
Exchange rates are determined on the basis of a fixed relationship to the SDR, within margins of up to ±7.25 percent. However, because of the maintenance of a relatively stable relationship with the U.S. dollar, these margins are not always observed.
Changes in the exchange rate vis-à-vis the pound sterling generally occur when the effective exchange rate, as calculated on the basis of the weighted currency basket, deviates by more than ± 1 percent from the pegged level.
Margins of ±6 percent are maintained with respect to the currencies of other countries participating in the exchange rate mechanism of the European Monetary System.
The exchange rate is maintained within margins of 5 percent on either side of a weighted composite of the currencies of the main trading partners.
The fluctuation band of the Bank of Finland’s currency index is currently about 4.5 percent (equivalent to margins of ±2 ½ percent).
The exchange rate is maintained within margins of ± 2.25 percent.
The exchange rate is maintained within margins of ± 2.5 percent in terms of the fixed relationship between the kwacha and the SDR.
Exchange Rate Arrangements, June 30, 19831
| Pegged | Flexibility Limited Vis-à-Vis a Single Currency or Group of Currencies | More Flexible | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| U.S. dollar | French franc |
Other currency |
SDR | Other composite |
Single currency2 |
Cooperative arrangements |
Adjusted according to a set of indicators |
Other man- aged floating |
Independ- ently float- ing |
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Zambia10 |
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Yugoslavia | ||||||||
No current information is available relating to Democratic Kampuchea. All members whose currencies are pegged to a single currency do so at present within zero fluctation margins. Members whose currencies are pegged to the SDR or “Other composite” maintain their exchange rates within zero or very narrow margins, seldom exceeding ±1 percent about the peg. Within the “Flexibility Limited” category, the “Single currency” subcategory lists those members that are observed to maintain an exchange arrangement such that their exchange rate fluctuates with a variability equivalent to 2¼ percent margins with respect to another member’s currency. The subclassification, “Cooperative arrangements,” lists the countries participating in the European Monetary System (EMS). With the exception of Italy, which maintains margins of 6 percent, these countries maintain 2¼ percent margins with respect to their cross rates based on the central rates expressed in terms of the European currency unit (ECU). Members with exchange arrangements listed under the “More Flexible” category are divided on the basis of the extent to which the authorities intervene in the setting of exchange rates. In some instances the exchange rate is allowed to move continuously over time; if the authorities intervene at all they do so only to influence, but not to neutralize, the speed of exchange rate movement. That exchange arrangement is classified as “Independently floating.” Alternatively, the exchange rate may be set for a short interval, usually one day to one week, and the authorities stand ready to buy and sell foreign exchange at the specified rate (the “managed floating” group).
All exchange rates have shown limited flexibility vis-à-vis the U.S. dollar.
Member maintains dual exchange markets involving multiple exchange arrangements. The arrangement shown is that maintained in the major market.
Exchange rates are determined on the basis of a fixed relationship to the SDR, within margins of up to ±7.25 percent. However, because of the maintenance of a relatively stable relationship with the U.S. dollar, these margins are not always observed.
Changes in the exchange rate vis-à-vis the pound sterling generally occur when the effective exchange rate, as calculated on the basis of the weighted currency basket, deviates by more than ± 1 percent from the pegged level.
Margins of ±6 percent are maintained with respect to the currencies of other countries participating in the exchange rate mechanism of the European Monetary System.
The exchange rate is maintained within margins of 5 percent on either side of a weighted composite of the currencies of the main trading partners.
The fluctuation band of the Bank of Finland’s currency index is currently about 4.5 percent (equivalent to margins of ±2 ½ percent).
The exchange rate is maintained within margins of ± 2.25 percent.
The exchange rate is maintained within margins of ± 2.5 percent in terms of the fixed relationship between the kwacha and the SDR.
Exchange Rate Arrangements, June 30, 19831
| Pegged | Flexibility Limited Vis-à-Vis a Single Currency or Group of Currencies | More Flexible | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| U.S. dollar | French franc |
Other currency |
SDR | Other composite |
Single currency2 |
Cooperative arrangements |
Adjusted according to a set of indicators |
Other man- aged floating |
Independ- ently float- ing |
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Zambia10 |
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Yugoslavia | ||||||||
No current information is available relating to Democratic Kampuchea. All members whose currencies are pegged to a single currency do so at present within zero fluctation margins. Members whose currencies are pegged to the SDR or “Other composite” maintain their exchange rates within zero or very narrow margins, seldom exceeding ±1 percent about the peg. Within the “Flexibility Limited” category, the “Single currency” subcategory lists those members that are observed to maintain an exchange arrangement such that their exchange rate fluctuates with a variability equivalent to 2¼ percent margins with respect to another member’s currency. The subclassification, “Cooperative arrangements,” lists the countries participating in the European Monetary System (EMS). With the exception of Italy, which maintains margins of 6 percent, these countries maintain 2¼ percent margins with respect to their cross rates based on the central rates expressed in terms of the European currency unit (ECU). Members with exchange arrangements listed under the “More Flexible” category are divided on the basis of the extent to which the authorities intervene in the setting of exchange rates. In some instances the exchange rate is allowed to move continuously over time; if the authorities intervene at all they do so only to influence, but not to neutralize, the speed of exchange rate movement. That exchange arrangement is classified as “Independently floating.” Alternatively, the exchange rate may be set for a short interval, usually one day to one week, and the authorities stand ready to buy and sell foreign exchange at the specified rate (the “managed floating” group).
All exchange rates have shown limited flexibility vis-à-vis the U.S. dollar.
Member maintains dual exchange markets involving multiple exchange arrangements. The arrangement shown is that maintained in the major market.
Exchange rates are determined on the basis of a fixed relationship to the SDR, within margins of up to ±7.25 percent. However, because of the maintenance of a relatively stable relationship with the U.S. dollar, these margins are not always observed.
Changes in the exchange rate vis-à-vis the pound sterling generally occur when the effective exchange rate, as calculated on the basis of the weighted currency basket, deviates by more than ± 1 percent from the pegged level.
Margins of ±6 percent are maintained with respect to the currencies of other countries participating in the exchange rate mechanism of the European Monetary System.
The exchange rate is maintained within margins of 5 percent on either side of a weighted composite of the currencies of the main trading partners.
The fluctuation band of the Bank of Finland’s currency index is currently about 4.5 percent (equivalent to margins of ±2 ½ percent).
The exchange rate is maintained within margins of ± 2.25 percent.
The exchange rate is maintained within margins of ± 2.5 percent in terms of the fixed relationship between the kwacha and the SDR.
Estimates of Import and Export Price Changes in Response to a Devaluation of 10 Percent
Estimates of Import and Export Price Changes in Response to a Devaluation of 10 Percent
| (In domestic currency terms) | |||||||
|---|---|---|---|---|---|---|---|
| Estimates by Spitäller (1980) | Estimates by Kreinin (1977) |
Estimates by Robinson, Webb, and Townsend (1979) |
|||||
| Import Prices | Export Prices | Import Prices | Export Prices | ||||
| Country | Six months | Two years | Six months | Two years | Two years | Six months | Two years |
| Belgium | 10.2 | 10.2 | 6.8 | 6.8 | 9.0 | 13.8 | 13.8 |
| Canada | 10.1 | 10.1 | 6.7 | 9.5 | … | 4.5 | 8.9 |
| France | 8.3 | 10.3 | 5.3 | 5.9 | … | 7.1 | 7.1 |
| Germany, Fed. Rep. | 7.3 | 7.3 | 1.7 | 2.6 | 6.0 | 7.7 | 9.3 |
| Italy | 10.9 | 10.9 | 8.7 | 10.5 | 10.0 | 9.9 | 9.9 |
| Japan | 11.5 | 11.5 | 5.9 | 5.9 | 8.0 | 12.1 | 6.5 |
| Netherlands | 6.6 | 11.6 | 6.8 | 6.8 | … | 5.7 | 6.0 |
| Sweden | 10.2 | 10.2 | 2.3 | 4.8 | … | 10.1 | 10.1 |
| United Kingdom | 9.3 | 10.6 | 3.5 | 5.6 | … | 7.9 | 7.9 |
| United States | 7.1 | 10.2 | 3.2 | 3.2 | 5.0 | 5.8 | 5.8 |
Estimates of Import and Export Price Changes in Response to a Devaluation of 10 Percent
| (In domestic currency terms) | |||||||
|---|---|---|---|---|---|---|---|
| Estimates by Spitäller (1980) | Estimates by Kreinin (1977) |
Estimates by Robinson, Webb, and Townsend (1979) |
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| Import Prices | Export Prices | Import Prices | Export Prices | ||||
| Country | Six months | Two years | Six months | Two years | Two years | Six months | Two years |
| Belgium | 10.2 | 10.2 | 6.8 | 6.8 | 9.0 | 13.8 | 13.8 |
| Canada | 10.1 | 10.1 | 6.7 | 9.5 | … | 4.5 | 8.9 |
| France | 8.3 | 10.3 | 5.3 | 5.9 | … | 7.1 | 7.1 |
| Germany, Fed. Rep. | 7.3 | 7.3 | 1.7 | 2.6 | 6.0 | 7.7 | 9.3 |
| Italy | 10.9 | 10.9 | 8.7 | 10.5 | 10.0 | 9.9 | 9.9 |
| Japan | 11.5 | 11.5 | 5.9 | 5.9 | 8.0 | 12.1 | 6.5 |
| Netherlands | 6.6 | 11.6 | 6.8 | 6.8 | … | 5.7 | 6.0 |
| Sweden | 10.2 | 10.2 | 2.3 | 4.8 | … | 10.1 | 10.1 |
| United Kingdom | 9.3 | 10.6 | 3.5 | 5.6 | … | 7.9 | 7.9 |
| United States | 7.1 | 10.2 | 3.2 | 3.2 | 5.0 | 5.8 | 5.8 |
Estimates of the Elasticity of Domestic Prices with Respect to Changes in Import Prices
Estimates of the Elasticity of Domestic Prices with Respect to Changes in Import Prices
| Estimates by Dornbusch and Krugman (1976) |
Estimates by Spitäller(1980) |
Estimates by Beenstock and Minford (1976) |
Estimates by Artus and McGuirk (1981) |
|
|---|---|---|---|---|
| Country | Consumer | Prices | Wholesale Prices |
GDP Deflator |
| Canada | 0.20 | 0.24 | 0.28 | 0.17 |
| France | 0.16 | 0.32 | 0.28 | 0.23 |
| Germany, Fed. Rep. | 0.03 | 0.08 | 0.23 | 0.22 |
| Italy | 0.28 | 0.36 | — | 0.16 |
| Japan | 0.24 | … | 0.20 | 0.14 |
| United Kingdom | 0.19 | 0.20 | — | 0.27 |
| United States | 0.14 | 0.16 | 0.05 | 0.14 |
Estimates of the Elasticity of Domestic Prices with Respect to Changes in Import Prices
| Estimates by Dornbusch and Krugman (1976) |
Estimates by Spitäller(1980) |
Estimates by Beenstock and Minford (1976) |
Estimates by Artus and McGuirk (1981) |
|
|---|---|---|---|---|
| Country | Consumer | Prices | Wholesale Prices |
GDP Deflator |
| Canada | 0.20 | 0.24 | 0.28 | 0.17 |
| France | 0.16 | 0.32 | 0.28 | 0.23 |
| Germany, Fed. Rep. | 0.03 | 0.08 | 0.23 | 0.22 |
| Italy | 0.28 | 0.36 | — | 0.16 |
| Japan | 0.24 | … | 0.20 | 0.14 |
| United Kingdom | 0.19 | 0.20 | — | 0.27 |
| United States | 0.14 | 0.16 | 0.05 | 0.14 |
Equations Relating Growth of World Output and World Trade1
Standard errors in parentheses.
Seven-country trade-weighted average of quarterly variability in real effective exchange rates (based on gross domestic product).
Equations Relating Growth of World Output and World Trade1
| Time Period |
Constant | Growth of World Output |
Real Exchange Rate Variability2 |
Real Exchange Rate Variability (Lagged)2 |
R̅2 | D - W | SEE |
|---|---|---|---|---|---|---|---|
| 1. 1959–82 | –1.47 (1.02) | 1.94 (0.22) | 0.76 | 2.00 | 2.05 | ||
| 2. 1962–82 | –3.16 (1.78) | 2.11 (0.25) | 0.57 (0.52) | 0.79 | 1.91 | 2.04 | |
| 3. 1963–82 | –2.56 (1.94) | 2.16 (0.32) | 0.32 (0.53) | 0.80 | 1.84 | 2.03 | |
| 4. 1959–71 | 2.63 (3.99) | 1.12 (0.79) | 0.08 | 1.82 | 2.31 | ||
| 5. 1974–82 | –1.85 (1.07) | 2.07 (0.34) | 0.82 | 2.49 | 1.97 |
Standard errors in parentheses.
Seven-country trade-weighted average of quarterly variability in real effective exchange rates (based on gross domestic product).
Equations Relating Growth of World Output and World Trade1
| Time Period |
Constant | Growth of World Output |
Real Exchange Rate Variability2 |
Real Exchange Rate Variability (Lagged)2 |
R̅2 | D - W | SEE |
|---|---|---|---|---|---|---|---|
| 1. 1959–82 | –1.47 (1.02) | 1.94 (0.22) | 0.76 | 2.00 | 2.05 | ||
| 2. 1962–82 | –3.16 (1.78) | 2.11 (0.25) | 0.57 (0.52) | 0.79 | 1.91 | 2.04 | |
| 3. 1963–82 | –2.56 (1.94) | 2.16 (0.32) | 0.32 (0.53) | 0.80 | 1.84 | 2.03 | |
| 4. 1959–71 | 2.63 (3.99) | 1.12 (0.79) | 0.08 | 1.82 | 2.31 | ||
| 5. 1974–82 | –1.85 (1.07) | 2.07 (0.34) | 0.82 | 2.49 | 1.97 |
Standard errors in parentheses.
Seven-country trade-weighted average of quarterly variability in real effective exchange rates (based on gross domestic product).
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Salop, Joanne, and Erich Spitäller, “Why Does the Current Account Matter?,” Staff Papers, International Monetary Fund (Washington), Vol. 27 March 1980, pp. 101–34.
Santomero, Anthony, and John J. Seater, “The Inflation-Unemployment Trade-Off: A Critique of the Literature,” Journal of Economic Literature (Nashville, Tennessee), Vol. 16 June 1978, pp. 499–544.
Shafer, Jeffrey R., and Bonnie E. Loopesko, “Floating Exchange Rates After Ten Years,” Brookings Papers on Economic Activity: 1 (1983),The Brookings Institution (Washington), pp. 1–70.
Solomon, Anthony M., “International Coordination of Economic Policies: I. The Role of Economic Summitry; II. Coordinating Monetary Policy?” The David Horowitz Lectures at Tel Aviv University, Tel Aviv, and Hebrew University, Jerusalem, March 4 and 5, 1982(unpublished).
Solomon, Robert, Reforming the Exchange-Rate Regime, International Economic Letter, RS Associates, Inc. (Washington), Vol. 3, No. 7 July 18, 1983.
Spitäller, Erich, “A Model of Inflation and Its Performance in the Seven Main Industrial Countries, 1958–76,” Staff Papers, International Monetary Fund (Washington), Vol. 25 June 1978, pp. 254–77.
Spitäller, Erich, “Short-Run Effects of Exchange Rate Changes on Terms of Trade and Trade Balances,” Staff Papers, International Monetary Fund (Washington), Vol. 27 June 1980, pp. 320–48.
Suss, Esther C., “A Note on Reserve Use Under Alternative Exchange Rate Regimes,” Staff Papers, International Monetary Fund (Washington), Vol. 23 July 1976, pp. 387–94.
Swoboda, Alexander K., “Exchange Rate Regimes and European-U.S. Policy Interdependence,” Staff Papers, International Monetary Fund (Washington), Vol. 30 March 1983, pp. 75–102.
Taylor, Dean, “Official Intervention in the Foreign Exchange Market, or, Bet Against the Central Bank,” Journal of Political Economy (Chicago), Vol. 90 April 1982, pp. 356–68
Thygesen, Niels, Exchange-Rate Experiences and Policies of Small Countries: Some European Examples of the 1970s, Essays in International Finance, No. 136, Princeton University (Princeton, New Jersey: Princeton University Press, December 1979.
Thursby, Marie C., and Jerry G. Thursby, “The Uncertainty Effects of Floating Exchange Rates: Empirical Evidence on International Trade Flows” (mimeographed, Columbus, Ohio: Ohio State University, 1981.
Tobin, James, A Proposal for International Monetary Reform, Cowles Foundation Paper No. 495, Cowles Foundation for Research in Economics (New Haven, Connecticut: Yale University Press, 1980.
Triffin, Robert, Gold and the Dollar Crisis: The Future of Convertibility (New Haven, Connecticut: Yale University Press, 1960.
Ungerer, Horst, Owen Evans, and Peter Nyberg, The European Monetary System: The Experience, 1979—82, Occasional Paper No. 19 (Washington: International Monetary Fund, May 1983.
U.S. Board of Governors of the Federal Reserve System, Federal Reserve Bulletin (Washington), various issues (1983).
U.S. Congress, Report to the Congress of the Commission on the Role of Gold in the Domestic and International Monetary Systems (Washington: Government Printing Office, March 1982.
U.S. Department of Labor, Bureau of Labor Statistics, Economic Projections to 1995 (Washington: Department of Labor, May 1984.
Volcker, Paul A., “The Role of Monetary Policy Coordination to Attain Exchange-Rate Stability,” in The New International Monetary System, ed. by Robert A. Mundell and Jacques J. Polak (New York: Columbia University Press, 1977, pp 25–36.
von Furstenberg, George M., “New Estimates of the Demand for Non-Gold Reserves Under Floating Exchange Rates,” Journal of International Money and Finance (Guildford, England), Vol. 1 April 1982, pp. 81–95.
Wachter, Michael L., “The Changing Cyclical Responsiveness of Wage Inflation,” Brookings Papers on Economic Activity: 1 (1976),The Brookings Institution (Washington), pp. 115–59.
Wallich, Henry C., “What Makes Exchange Rates Move?,” Challenge (New York) July/August 1977, pp. 34–40.
Wallich, Henry C., “Reflections on the U.S. Balance of Payments,” Challenge (New York) March/April 1978, pp. 56–59.
Willett, Thomas D., Floating Exchange Rates and International Monetary Reform, American Enterprise Institute Studies in Economic Policy (Washington: American Enterprise Institute for Public Policy Research, 1977.
Williamson, John, “Exchange-Rate Flexibility and Reserve Use,” Scandanavian Journal of Economics (Stockholm) Vol. 78, No. 2 (1976), pp. 327–39.
Williamson, John, “The Failure of Global Fixity,” in EMS: The Emerging European Monetary System, ed. by Robert Triffin (Brussels: National Bank of Belgium, 1979, pp. 21–40.
Williamson, John, International Monetary Reform: A Survey of the Options, Report to the Group of Twenty-Four, Studies on International Monetary and Financial Issues for the Developing Countries, UNDP/UNCTAD Project INT/75/015 (New York: United Nations Development Program, June 1980.
Williamson, John, The Exchange Rate System (Washington: Institute for International Economics, September 1983.
Witteveen, H. Johannes, “Developing a New International Monetary System: A Long-Term View,” The 1983 Per Jacobsson Lecture (Washington: Per Jacobsson Foundation, September 1983.
Working Group on Exchange Market Intervention, Report of the Working Group on Exchange Market Intervention (processed, March 1983.
The importance of managing international liquidity under floating rates is analyzed by Haberler (1977) and Crockett (1978).
Such old problems include the effect of liability rather than asset settlement of external imbalances on the incentive to adjust, large and sudden demand shifts among reserve currencies, the different attitudes about the valuation of gold in public versus private portfolios, and the method for ensuring an appropriate transfer of real resources to the developing countries.
Examples of these new problems are the abrupt shifts in commercial bank lending to developing countries, the identification of lender of last resort in the Eurocurrency markets, and keeping the SDR viable during periods when there are no allocations. Some of these new problems are discussed by Witteveen (1983).
This restriction may not be very serious because at least three recent studies (Cline (1976), Williamson (1980), and Helleiner (1981)) focus specifically on the impact of the exchange rate regime on developing countries. Also, see the Brandt report (1980), pp. 201—20. Finally, Chapter 2 in the Fund’s Annual Report traditionally contains an assessment of how developing countries are coping with problems of the exchange rate system.
In 1982, for example, the seven largest industrial countries accounted for 51 percent of world exports and 51 percent of world imports.
These structural factors include the breadth and depth of financial markets, the commodity structure and openness of trade, and the degree of real wage flexibility in labor markets.
International Monetary Fund, Articles of Agreement (IMF (1946)), Article IV, Section 5 (a) and (b).
For example, the Fund’s 1982 Annual Report (IMF (1982 a, p. 58) indicates that between 1975 and 1981 the proportion of Fund membership that maintained pegged exchange arrangements declined from 78 percent to 65 percent while participation in the residual category “other arrangements” increased from 12 percent to 26 percent. During the same time span, the proportion of single-currency pegs among all peggers dropped from 72 percent to 62 percent; also, within single-currency peggers, the proportion of dollar peggers fell slightly from 69 percent to 68 percent (in trade-weighted terms, however, the shift away from dollar pegging was much more pronounced).
Some of the recent theoretical literature supports this conjecture; for example, see Branson (1983), Frenkel and Aizenman (1982), and Lipschitz and Sundararajan (1980).
Article IV, Section 1 (IMF (1978)). Article IV, Section 4, of the First Amendment (IMF (1968)) enjoined members “to collaborate with the Fund, to promote exchange stability, to maintain orderly exchange arrangements with other members, and to avoid competitive exchange alterations.”
Article IV, Section 1(i) and (ii) of the Fund’s Articles (IMF (1978)).
Article IV, Section 4 (a) of the original Articles (IMF (1946)).
Article IV, Section 3 (a) and (b).
Not surprisingly, this increase in variability has not been uniform across currencies. Specifically, IMF (1984 a) reports that variability of the real effective exchange rate has been greater for the U.S. dollar, the pound sterling, and the Japanese yen than for the French franc, the deutsche mark, the Italian lira, and the Canadian dollar. Lanyi and Suss (1982) similarly demonstrate that exchange rate variability during the 1973–79 period has differed by type of exchange arrangements.
Actually, even over the long run, there have been some notable departures from purchasing power parity. See Home (1983).
Nordhaus (1978) and Frenkel and Mussa (1980) obtain similar conclusions.
See Mussa (1983). Another piece of supporting evidence is that structural models of exchange rate determination have proved no better than naive models in forecasting exchange rates out of sample (e.g., see Meese and Rogoff (1983) and Dooley and Isard (1983)).
See Taylor (1982), Dooley (1980–81), and the Working Group on Exchange Market Intervention (1983).
The ten members of the Fund adhering to the General Arrangements to Borrow, which entered into force on October 24, 1962, became known as the Group of Ten. They comprised Belgium, Canada, France, the Federal Republic of Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States.
For example, interventions in the deutsche mark-dollar market alone were apparently on the order of DM 18 billion in 1980, DM 21 billion in 1981, and DM 7 billion in 1982. See the Annual Report of the Deutsche Bundesbank (1982, p. 72).
See von Furstenberg (1982) for a discussion of how reserve supply arrangements have changed since the inception of widespread floating rates.
A similar comparison for the 1963–72 and 1973–78 periods appears in Goldstein (1980) and tells essentially the same story.
See Heller (1976) and Black (1978). Some observers might also include the commodity boom of 1972–74 as another major disturbance. It is excluded here because it may not have been totally exogenous to the exchange rate regime, with some economists (e.g., Cooper and Lawrence (1975)) citing the exchange rate instability of 1973–74 as a contributing factor to the speculation in commodities.
It needs to be recognized that the policy response to the two oil price disturbances differed in some important respects. For example, both monetary and fiscal policy were much less accommodating following the second oil price disturbance than following the first one; see IMF (1982 b) and Larsen and Llewellyn (1983).
A recent study for the Organization for Economic Cooperation and Development (OECD) by Larsen and Llewellyn (1983) suggests that each of the two oil price disturbances raised the OECD general price level by about 2 percentage points relative to what it would have been otherwise. Nordhaus’s (1980) estimates of the impact of the oil price disturbances on macroeconomic performance of OECD countries are more modest but still suggest adverse effects on inflation, real income growth, and unemployment. Heller’s (1976) analysis implies that the 1970–72 expansion in international reserves was an important factor in the high inflation rates of the 1973–75 period; Laney and Willett (1982) offer an opposing view.
In some industrial countries (e.g., France, the Federal Republic of Germany, the United Kingdom, and the United States), this so-called real wage gap has risen again since 1979. See Sachs (1983).
See the Fund Managing Director’s speech on “The Impact of Interest Rates on International Finance and Trade” (de Larosière (1982)).
Special incentives to capital flows need to be interpreted broadly. They would include not only, say, tax advantages or disadvantages but also an interest rate that was reflecting an unsustainable mix of monetary and fiscal policies. Also, unemployment should be viewed as a proxy for a whole range of cyclical or temporary factors. Finally, where the country’s level of international reserves is unduly low or high, it might be desirable to allow for some change in reserves.
For example, the 1970 report by Executive Directors of the Fund on the role of exchange rates in the adjustment of international payments (IMF (1970, p. 48)) noted: “Thus, the criterion of fundamental disequilibrium is wider than the occurrence of a disequilibrium in the actual balance of payments. . . . For example, the concept of fundamental disequilibrium could include a balance of payments position that would have shown a deficit but for restrictions on trade and payments; or a situation of equilibrium (or surplus) in the balance of payments that would turn into a deficit but for an unacceptably low rate of economic activity in the country; or a situation of equilibrium (or deficit) in the balance of payments that would turn into a surplus but for exports of capital at a rate that the country concerned did not wish to continue, or but for the country’s acquiescence in an unacceptably high rate of inflation.” A recent Fund study (IMF (1984 b)) implies a very similar definition of equilibrium payments balance.
See, for example, Artus (1978) and IMF (1984 b). Similarly, Williamson (1983, p. 14) defines the fundamental equilibrium exchange rate as that “…which is expected to generate a current account surplus or deficit equal to the underlying capital flow over the cycle, given that the country is pursuing ‘internal balance’ as best it can and not restricting trade for balance of payments reasons.”
Article I of the Fund’s Articles of Agreement cites as one of the purposes of the Fund “to facilitate the expansion and balanced growth of international trade” (IMF (1978)).
Other appraisals of experience with managed floating can be found in Willett (1977), Black (1977), Artus and Young (1979), Goldstein (1980), Dornbusch (1980), Williamson (1983), Solomon (1983), and Shafer and Loopesko (1983).
Managed floating can still, however, be differentiated from the adjustable peg system by the greater frequency of exchange rate changes, by the larger share of the external adjustment burden that is assigned to the exchange rate, and by the absence of a publicly declared target exchange rate that must be defended except in a situation of fundamental disequilbrium.
See Ungerer, Evans, and Nyberg (1983) for a listing of these exchange rate realignments. The “snake” refers to the adjustable peg system operated by some European countries in 1972–78, under which there were small and frequent adjustments of exchange rates.
Whereas the average annual increase in broad money for the seven major industrial countries was about 12 percent in both 1963–72 and 1973–82, the corresponding figure for 1979–82 was less than 10 percent. If real monetary aggregates were used, the contrast with the 1979–82 period would be more marked.
For some of these countries, the declines were much more frequent. For example, import prices in the Federal Republic of Germany fell in 10 of the 18 years during 1956–73—clearly too often to be regarded as a temporary or unusual event.
See also Bond (1980) and Bilson (1979) for analyses of the vicious circle.
These intercountry differences are reduced but not eliminated if one considers deflators of value-added rather than consumer prices (see Table 8 in the Appendix).
Consistent with this proposition, Spitäller (1978) found that the response of inflation to its determinants was almost three times as fast in industrial countries from 1973 to 1976 as from 1958 to 1976 as a whole. Also, Robinson, Webb, and Townsend (1979) concluded that the feedback of exchange rate changes to domestic price changes was larger and quicker in the 1970s than in the 1950s and 1960s.
For a good survey of the theoretical and empirical work on efficiency in the foreign exchange markets, see Levich (1984).
The report of the Working Group on Exchange Market Intervention (1983) cites a number of such “bandwagon” episodes.
See IMF (1983, Table 6)). Using fourth quarter figures rather than annual averages, the unemployment rate for 1983 would be lower than for 1982.
It was also sometimes argued that floating rates would reduce unemployment by permitting some countries to maintain higher rates of inflation than would be possible under fixed rates. This argument has lost its force, however, with the acceptance of the vertical nature of the long-run Phillips curve (see Santomero and Seater (1978) for a survey of the relevant empirical evidence). In other words, if the natural rate of unemployment is independent of the rate of inflation, then flexible rates cannot buy high-inflation countries more employment, nor can fixed rates cost less than employment (see Artus and Young (1979)).
The real effective rate used here is the ratio of own to competitors’ normalized unit labor cost adjusted for exchange rate changes.
The same kind of argument can be made about the effect of the wrong exchange rate on variations in consumption (i.e., the so-called welfare cost of disequilibrium exchange rates). See Hause (1966).
See Forsyth and Kay (1980), who estimate that the equilibrium response to the discovery of North Sea oil was a real appreciation of 18 percent. Bond and Knobl (1982) estimate that perhaps half of the real appreciation in sterling between 1977 and 1981 was due to the existence of North Sea oil and to the rise in real price of oil. Buiter and Miller (1983) and Williamson (1983) argue for lower figures.
Medoff (1983) notes, for example, that the U.S. civilian labor force grew by 1.1 percent a year in the 1950s, 1.7 percent in the 1960s, and 2.5 percent in the 1970s; also the forecasts of the U.S. Department of Labor, Bureau of Labor Statistics (1984), for the 1980s and 1990s are 1.4 percent and 0.5 percent, respectively.
Consistent with this conclusion, Sachs (1983) finds that he can explain the behavior of aggregate unemployment rates in six major industrial countries over the 1961–81 period by reference to real money balances, the excess of real wages over trend productivity, lagged unemployment, and a time trend.
Because of the size of the real appreciation of sterling between 1977 and 1981, the United Kingdom probably stands as an exception to this conclusion.
By a “small” country, it is meant one in which the price level and the interest rate are basically determined in the rest of the world.
For recent reviews, see Kreinin and Officer (1978) and Laney and Willett (1982).
Obstfeld (1982), for example, found that capital flows offset about 50–65 percent of the change in the Deutsche Bundesbank’s net domestic assets during the 1960–70 period.
Argy (1982) provides an account and appraisal of how this mixed strategy worked during the period of floating rates in the Federal Republic of Germany, Japan, and the United Kingdom.
Simple calculations of the standard deviation (or coefficient of variation) of money supply growth across the seven major industrial countries show that the intercountry dispersion has increased marginally in moving from 1963–72 to 1973–82. Using more sophisticated measures of country synchronization, Swoboda (1983) finds no significant change in monetary interdependence across exchange rate regimes.
See Argy and Salop (1979), Branson and Rotenberg (1980), and Sachs (1983). More generally, the effects of expansionary monetary and fiscal policies on real output also depend on whether workers bargain for after-tax real income and whether workers and producers use different price deflators for calculating real wages (see Argy and Salop (1979) and Dornbusch (1983)).
Solomon (1983) expands upon this argument.
Other significant factors are the country’s access to international capital markets and the degrees of openness, of factor mobility, of export diversification, and of wage-price flexibility.
See Mussa (1979) for a demonstration of these results.
To the extent that fiscal imbalances affect real interest rates, errant fiscal policies can also be considered as real disturbances.
The only macroeconomic variable that seems to show markedly less synchronization in the period of floating rates is the rate of inflation (see Swoboda (1983)). Even here, however, the data may also be reflecting the tendency for the variability of inflation, both within and across countries, to increase with the mean rate of inflation (see, for example, Logue and Willett (1976)).
As detailed later, there are few estimates of equilibrium payments balance for industrial countries and they typically begin only in 1975.
The analogous figures for the seven major industrial countries were 0.4 for 1963–72 and –2.1 percent for 1973–82.
Salop and Spitäller (1980) provide an interesting sample of official pronouncements on the current account during the 1970–79 period.
Expressing current account imbalances as a ratio to GNP not only serves as a scale adjustment for cross-country comparisons but also makes some adjustment for current account changes achieved via abnormally high or low growth rates of real income.
In calculating the mean ratio of the current account to GNP for each individual country, account is taken of the sign of the current account. In contrast, in computing the group average, absolute values of the ratio are employed.
While the assumption that the optimal current account is zero is difficult to defend in principle, it is interesting to note that Penati and Dooley (1983) found that, for 19 industrial countries as a group, there was no long-run tendency for the ratio of the current account to GNP to depart from zero over the 1949–81 period.
In interpreting the results for the smaller industrial countries, it is useful to recall that most of these countries adopted some form of limited flexibility or pegged exchange arrangements during the past decade. Thygesen (1979) provides an analysis of exchange rate policy for these countries over the period of floating rates.
For example, the mean ratios of the current account to GNP during 1953–62 were 1.17 and 0.69 for the larger and smaller industrial countries, respectively. Also, Dornbusch (1980) reached the same conclusion for the four largest industrial countries in a comparison of the 1960–73 and 1973–79 periods.
In making this adjustment for the statistical asymmetry, it was assumed: (1) that there was no asymmetry in the 1963–72 period, and (2) that for each year during the 1973–82 period, the share of each large industrial country in the global asymmetry could be approximated by its share of world exports during 1973–82. These figures for asymmetry were then added to the current account for that year to derive a new ratio of current account to gross national product for each large industrial country. The results were very similar to those reported in Table 2.
As noted earlier, one has to be careful here to consider also whether the real rate of return on domestic assets is not artificially high or low because of the presence of special incentives for, or restrictions on, international capital flows. If, for example, the real interest rate is artificially high because of an unsustainably large budget deficit, then the structure of that country’s balance of payments is not likely to be either sustainable or internationally optimal. More generally, a proper evaluation of the equilibrium balance of payments should consider the sustainability and optimality of the public sector’s tax and expenditure structure.
These problems include adjusting observed capital flows for large changes in fiscal positions, for structural economic changes (e.g., natural resource discoveries), and for changes in restrictions on capital flows. Also, one has to decide which (if any) official capital flows to include. All these problems are discussed at some length in the recent Fund staff study (IMF (1984 b)) on issues in the assessment of exchange rates of industrial countries.
Specifically, normal capital flows (NCF) are defined as NCFt = [CFt + 1 + CFt + CFt – 1 + CFt – 2]/4.0, where CFt is the ratio of net private capital flows to GNP in year t. The allocation of errors and omissions to the capital account is rather arbitrary, but does not seem to affect the qualitative nature of the conclusions reached. A more serious problem with any such mechanical formula for normal capital flows is that it cannot totally filter out short-term disequilibria. The experience of Japan in 1973/74 and again in 1979/80, when unusually large capital flows through the domestic banking system were coincidental with short-term oil deficits, serves as a good case in point.
Because the calculations in Table 3 do not account for any changes in desired reserves over time, the possibility cannot be dismissed that the figures reflect some combination of adjustment efforts and of changes in desired reserve holdings.
Also worth noting is the cessation of the explosive trend in the serial correlation of the U.S. payments indicator that was evident in the 1966–72 period.
This statement is also true when the calculations in Table 2 are redone for the 1965–72 and 1973–81 periods used in Table 3.
For the six larger industrial countries (excluding France), the only case where the mean current account or mean capital account ratio gets much above 1 percent is Canada, where both ratios stand at about 2 percent for the 1963–72 period. Even in this case, however, the mean ratios carry opposite signs.
The financing of energy projects is also relevant for U.K. capital flows in the 1970s. Similarly, the increase in quasi-official borrowing also accounts for much of the rise in Italian net capital inflows since the mid–1970s. Finally, the relaxation of capital controls is relevant for explaining net capital flows in Japan, the United Kingdom, and the United States during part of the 1970s (see IMF (1984 b)).
In Fund terminology, “underlying payments balances” refer to actual payments balances adjusted for temporary factors, earlier exchange rate changes, desired reserve changes, and anticipated future developments (including anticipated future policies). The equilibrium payments balance can then be defined as a situation where the underlying current account is equal to normal capital flows.
Two advantages of taking expected future policies into account are that it eliminates the need to estimate a normal cyclical position and that it brings added realism to the exercise (in the sense that private market participants clearly take expected future developments into account in assessing exchange rates).
In interpreting Table 4, it should be kept in mind that the estimates of normal capital flows, while not based on mechanical formulas, are still subject to rather wide margins of error—especially in the recent situation when there have been large changes in fiscal positions and/or significant structural changes in capital markets (e.g., liberalization of capital flows) in some of the largest industrial countries.
Yet another approach to assessing the adequacy of external adjustment is to examine the incentives for adjustment; on this score, see Kafka (1976).
Most of the arguments in this subsection draw heavily on Goldstein (1980).
See the staff exercise reported in the Fund’s Annual Report, 1978, p. 42.
For the classic theoretical presentation of overshooting, see Dornbusch (1976).
For a summary of these discussions, see Cumby (1982).
The role of the dollar as the primary reserve asset also gave rise to the debate about whether the U.S. payments deficit in the 1960s was “supply determined” or “demand determined.”
It is perhaps ironic that the greater symmetry of adjustment sought by the Committee of Twenty seems to have been aided not by imposing asset settlement on reserve centers but rather by extending the unwarranted privilege of liability settlement to many non-reserve-center countries.
Following Polak (1981), coordination may be thought of here as including all international influences on domestic economic decision making.
See Polak (1981), Dreyer (1982), and Solomon (1982) for accounts of coordination measures taken during the period of floating rates and before. Also see “Evolution of Surveillance Function of the Fund Reflects Changing Economic Situation of Members,” IMF Survey, Vol. 13 (April 19, 1984), pp. 98–100.
See IMF Survey (IMF (1982 b)). The recent report by a Commonwealth Study Group on challenges for the world financial and trading system (i.e., Helleiner (1983, p. 31)) also places strong emphasis on better coordination of national macroeconomic policies among the major industrial countries for promoting smooth and equitable adjustment to international payments imbalances.
Although international coordination of policies is often associated with coordination of monetary policies, developments of the past few years stand as testimony to the international externalities of unstable and uncoordinated fiscal policies.
For example, in discussing why freely fluctuating exchange rates would be undesirable, Nurkse (1945, pp. 5–6), states: “For one thing, they create considerable exchange risks, which tend to discourage international trade. “Likewise, in assessing freely floating exchange rates, the report by the Fund’s Executive Directors on the role of exchange rates in the adjustment of international payments (IMF (1970, p. 42)) argues: “The fluctuations in exchange rates that occurred, and the absence of any limits on the scope for potential fluctuations, would involve damaging uncertainties for international trade.”
The volume effect is unambiguous because the backward shifts induced in the supply curve and the demand curve each reduce the volume of trade. However, the price effects of increased uncertainty could in principle go in either direction. See, for example, Hooper and Kohlhagen (1978).
For example, if relative price uncertainty is a major factor in decisions on resource allocation, increased exchange rate uncertainty could result in a gradual shift away from traded goods industries (which are more exposed to such uncertainty stemming from exchange rate fluctuations) and toward nontraded goods in the service and other sectors. A multinational firm, in deciding where to locate new investment, needs to be aware not only of technical factors affecting cost but also of uncertainties of currency relationships. This can lead to a diversification of investment, even at some cost in terms of efficiency, in order to minimize the risks arising from currency instability.
See the discussion above under Floating Rates and Unemployment.
In 1963–73 world output (excluding construction and services) rose by 6 percent annually versus 3 percent for 1974–80, 1 percent in 1981, and 0 percent in 1982.
Exceptions to this general conclusion can be found in the econometric studies by Coes (1981), Thursby and Thursby (1981), and Cushman (1983). However, the Fund staff study (IMF (1984 a)) suggests that these studies establish an empirical link between exchange rate variability and trade volumes that are only subject to particular conditions.
It should also be kept in mind that the Fund staff study (IMF (1984 a, p. 37)) does not address the question of “. . . whether or not prolonged shifts in underlying conditions that cause sustained departures from some medium-term trend in exchange rate relationships are harmful for trade.”
The surveys covered in the Fund staff study (IMF (1984 a)) include: Duerr (1977), Fieleke (1978), Group of Thirty (1980); and Blin, Greenbaum, and Jacobs (1981).
At the same time, the Fund staff study (IMF (1984 a)) did find some suggestive evidence that the variance or volatility of resource shifts in and out of the foreign sector was greater in 1974–82 than in 1960–70.
In addition, there are examples of moves toward trade liberalization being introduced in the face of large exchange rate variability (e.g., the Tokyo Round of Multilateral Trade Negotiations in 1973–79 and the later stages of the Generalized System of Preferences, which was phased in by the industrial countries during 1966–76).
Kenen (1979, p. 163) makes this same point: “In the flexible rate system we have found a device for achieving exchange rate changes without raising them to the highest level of public policy both domestic and international.”
On this point, de Vries (1980) makes a distinction between the Bretton Woods type of adjustable peg system (under which exchange rates were changed infrequently and by large amounts) and the adjustable peg system (the snake) operated by some European countries in 1972–78 (under which exchange rates were adjusted frequently and in small amounts). He considers the former but not the latter to be incompatible with high international mobility of capital.
Of course, not all structural factors are immutable. For example, a change in labor bargaining practices that results in an increased flexibility of real wages can change a country that was an unlikely candidate for more exchange rate flexibility into an attractive candidate.
Note that so long as exchange rate behavior is specified in terms of real exchange rates, this objective can in principle be satisfied either by fixed rates, or flexible rates, or by any combination of them.
The interim Guidelines for the Management of Floating Exchange Rates (IMF (1976)) contained a similar provision for intervention behavior.
The idea of using exchange rate movements as a guide or indicator for domestic monetary policy is often defended on the grounds that alternative indicators (e.g., interest rates, monetary aggregates) are becoming increasingly unreliable due to inflationary expectations or technological and regulatory considerations.
Occasional Papers of the International Monetary Fund
2. Economic Stabilization and Growth in Portugal, by Hans O. Schmitt. 1981.
5. Trade Policy Developments in Industrial Countries, by S.J. Anjaria, Z. Iqbal, L.L. Perez, and W.S. Tseng. 1981.
6. The Multilateral System of Payments: Keynes, Convertibility, and the International Monetary Fund’s Articles of Agreement, by Joseph Gold. 1981.
8. Taxation in Sub-Saharan Africa. Part I: Tax Policy and Administration in Sub-Saharan Africa, by Carlos A. Aguirre, Peter S. Griffith, and M. Zühtü Yücelik. Part II: A Statistical Evaluation Taxation in Sub-Saharan Africa, by Vito Tanzi. 1981.
10. International Comparisons of Government Expenditure, by Alan A. Tait and Peter S. Heller. 1982.
11. Payments Arrangements and the Expansion of Trade in Eastern and Southern Africa, by Shailendra J. Anjaria, Sena Eken, and John F. Laker. 1982.
12. Effects of Slowdown in Industrial Countries on Growth in Non-Oil Developing Countries, by Morris Goldstein and Mohsin S. Khan. 1982.
13. Currency Convertibility in the Economic Community of West African States, by John B. McLenaghan, Saleh M. Nsouli, and Klaus-Walter Riechel. 1982.
14. International Capital Markets: Developments and Prospects, 1982, by a Staff Team Headed by Richard C. Williams, with G.G. Johnson. 1982.
15. Hungary: An Economic Survey, by a Staff Team Headed by Patrick de Fontenay. 1982.
16. Developments in International Trade Policy, by S.J. Anjaria, Z. Iqbal, N. Kirmani, and L.L. Perez. 1982.
17. Aspects of the International Banking Safety Net, by G.G. Johnson, with Richard K. Abrams. 1983.
18. Oil Exporters’ Economic Development in an Interdependent World, by Jahangir Amuzegar. 1983.
19. The European Monetary System: The Experience, 1979–82, by Horst Ungerer, with Owen Evans and Peter Nyberg. 1983.
20. Alternatives to the Central Bank in the Developing World, by Charles Collyns. 1983.
22. Interest Rate Policies in Developing Countries: A Study by the Research Department of the International Monetary Fund. 1983.
24. Government Employment and Pay: Some International Comparisons, by Peter S. Heller and Alan A. Tait. 1983. Revised 1984.
26. The Fund, Commercial Banks, and Member Countries, by Paul Mentré. 1984.
28. Exchange Rate Volatility and World Trade: A Study by the Research Department of the International Monetary Fund. 1984.
29. Issues in the Assessment of the Exchange Rates of Industrial Countries: A Study by the Research Department of the International Monetary Fund. 1984.
30. The Exchange Rate System—Lessons of the Past and Options for the Future: A Study by the Research Department of the International Monetary Fund. 1984.
33. Foreign Private Investment in Developing Countries: A Study by the Research Department of the International Monetary Fund. 1985.
34. Adjustment Programs in Africa: The Recent Experience, by Justin B. Zulu and Saleh M. Nsouli. 1985.
Note: Excludes those titles that are now out of print or that are now included in the series “World Economic and Financial Surveys.”
35. The West African Monetary Union: An Analytical Review, by Rattan J. Bhatia. 1985.
36. Formulation of Exchange Rate Policies in Adjustment Programs, by a Staff Team Headed by G.G. Johnson. 1985.
38. Trade Policy Issues and Developments, by Shailendra J. Anjaria, Naheed Kirmani, and Arne B. Petersen. 1985.
39. A Case of Successful Adjustment: Korea’s Experience During 1980–84, by Bijan B. Aghevli and Jorge Márquez-Ruarte. 1985.
41. Fund-Supported Adjustment Programs and Economic Growth, by Mohsin S. Khan and Malcolm D. Knight. 1985.
42. Global Effects of Fund-Supported Adjustment Programs, by Morris Goldstein. 1986.
44. A Review of the Fiscal Impulse Measure, by Peter S. Heller, Richard D. Haas, and Ahsan H. Mansur. 1986.
45. Switzerland’s Role as an International Financial Center, by Benedicte Vibe Christensen. 1986.
46. Fund-Supported Programs, Fiscal Policy, and Income Distribution: A Study by the Fiscal Affairs Department of the International Monetary Fund. 1986.
47. Aging and Social Expenditure in the Major Industrial Countries, 1980–2025, by Peter S. Heller, Richard Hemming, Peter W. Kohnert, and a Staff Team from the Fiscal Affairs Department. 1986.
48. The European Monetary System: Recent Developments, by Horst Ungerer, Owen Evans, Thomas Mayer, and Philip Young. 1986.
49. Islamic Banking, by Zubair Iqbal and Abbas Mirakhor. 1987.
50. Strengthening the International Monetary System: Exchange Rates, Surveillance, and Objective Indicators, by Andrew Crockett and Morris Goldstein. 1987.
51. The Role of the SDR in the International Monetary System, by the Research and Treasurer’s Departments of the International Monetary Fund. 1987.
52. Structural Reform, Stabilization, and Growth in Turkey, by George Kopits. 1987.
53. Floating Exchange Rates in Developing Countries: Experience with Auction and Interbank Markets, by Peter J. Quirk, Benedicte Vibe Christensen, Kyung-Mo Huh, and Toshihiko Sasaki. 1987.
54. Protection and Liberalization: A Review of Analytical Issues, by W. Max Corden. 1987.
55. Theoretical Aspects of the Design of Fund-Supported Adjustment Programs: A Study by the Research Department of the International Monetary Fund. 1987.
56. Privatization and Public Enterprises, by Richard Hemming and Ali M. Mansoor. 1988.
57. The Search for Efficiency in the Adjustment Process: Spain in the 1980s, by Augusto Lopez-Claros. 1988.
58. The Implications of Fund-Supported Adjustment Programs for Poverty: Experiences in Selected Countries, by Peter S. Heller, A. Lans Bovenberg, Thanos Catsambas, Ke-Young Chu, and Parthasarathi Shome. 1988.
59. The Measurement of Fiscal Impact: Methodological Issues, edited by Mario I. Blejer and Ke-Young Chu. 1988
60. Policies for Developing Forward Foreign Exchange Markets, by Peter J. Quirk, Graham Hacche, Viktor Schoofs, and Lothar Weniger. 1988.
International Monetary Fund, Washington, D.C. 20431, U.S.A.
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