TWELVE YEARS HAVE PASSED since the advent of generalized floating in March 1973, and by now considerable experience has accumulated with the operation of the present mixed system. Under this system, the currencies of the largest countries float, in some cases jointly with other major currencies, while most other countries continue to have exchange arrangements involving pegs or other mechanisms that limit exchange rate flexibility. Countries with floating exchange rates often try to influence them through various means, but unlike the other countries they do not try to maintain their rate at a particular level (which in arrangements such as crawling pegs may be changes frequently) through intervention or restrictions on exchange transactions.

TWELVE YEARS HAVE PASSED since the advent of generalized floating in March 1973, and by now considerable experience has accumulated with the operation of the present mixed system. Under this system, the currencies of the largest countries float, in some cases jointly with other major currencies, while most other countries continue to have exchange arrangements involving pegs or other mechanisms that limit exchange rate flexibility. Countries with floating exchange rates often try to influence them through various means, but unlike the other countries they do not try to maintain their rate at a particular level (which in arrangements such as crawling pegs may be changes frequently) through intervention or restrictions on exchange transactions.

This paper is mainly concerned with the role that international surveillance, particularly by the International Monetary Fund, plays in influencing exchange rate developments and policies. Before turning to this subject it is useful to note briefly some of the economic issues that arise out of the current mixed system. There is, of course, a wealth of economic literature on this subject, and a brief review of this sort can do no more than indicate the issues involved.1

The Experience With Floating Exchange Rates

In evaluating the experience with floating rates, the most obvious standard of comparison is the par value system that preceded the present system. Floating rates were perhaps inescapable in the 1970s, given the economic shocks that occurred, the divergence of economic policies among the major countries (a factor that contributed to the breakdown of the par value system, and which became even more important in the 1970s), and the rapid growth of international capital flows that liberalization of capital movements and the development of capital markets entailed. Under these circumstances it is difficult to imagine that a par value system could have functioned at all smoothly, even if countries had been more disposed to adjust exchange rates in the face of “fundamental disequilibria” than they had been during the par value era. If countries had committed themselves to achieving convergent economic conditions, the magnitude of the economic shocks could have been mitigated, and it is conceivable that the par value system could have carried on with a moderate number of adjustments to par values. Given the actual situation, however, floating rates no doubt permitted a smoother adjustment of exchange rates and payments balances than could have occurred through a series of crises leading to changes in par values.

A key criterion for evaluating the appropriateness of exchange rates is their role in balance of payments adjustment. From this point of view, the experience since 1972 seems relatively favorable. Though noting the many thorny conceptual issues involved in appraising this experience, International Monetary Fund (1984c, pp. 48–49) nonetheless concludes that despite the need for major external adjustments among the major industrial countries, the average size and the average duration of payments imbalances of those countries were smaller during the years 1973–81 than under the last ten years of the par value system. Developments since 1981, however, particularly with respect to the United States, suggest that this conclusion needs to be modified to some degree.

A second important issue that arises with floating rates is their volatility. This question has been explored at length in another study by the Fund (1984a), which examines the short-term variability of exchange rates between 1960 and 1983. That study concludes (on p. 12) that variability of nominal effective exchange rates was much higher in the years 1974–83 than it was in 1961–70. Variability of real effective exchange rates has also increased, but less than nominal rates, while under the par value system the variability of real effective rates was higher than that of nominal rates. This suggests that at least part of the variability of nominal rates in the latter period has reflected inflation differentials.

These comparisons say little about the relative merits of floating versus fixed rates, since as noted above it seems clear that the par value system could have survived only with much greater exchange rate flexibility than it had previously demonstrated. Nonetheless, the recent high short-term volatility of exchange rates has been a major issue. While the uncertainty associated with such volatility may have negative effects on trade and output, increasingly effective mechanisms have developed to permit traders to protect themselves, albeit at some cost, against short-term fluctuations. In any case most of the papers referred to in the Fund study conclude that there is no empirical evidence of a negative effect on trade and investment, and the study suggests that even if such effects could be detected, they might be attributable to the factors leading to exchange rate volatility rather than to the volatility itself.

Whatever the effects of the uncertainty associated with the short-term volatility of exchange rates, sustained changes over the medium term have far-reaching effects. Changes in nominal exchange rates that merely reflect inflation differentials are consistent with maintaining competitiveness (the relative costs of producing tradable goods). Real depreciations or appreciations, however, initially encourage changes in the production of tradables and, depending on the magnitude and duration of the exchange rate change, they may induce permanent shifts of resources. Where new developments, such as the exploitation of new types of resources or secular changes in savings behavior, have enduring effects on payments balances, changes in real effective exchange rates can promote adjustment to the new situation. Even where the new developments are transitory, some change in real rates helps to smooth their effects on payments balances.2 By the same token, however, sustained changes in competitiveness in response to transitory disturbances can result in wasteful major shifts of resources to or from production of tradables. The painfulness of such shifts can be a major factor in pressures for protectionism.

The chart traces the broad swings in real effective exchange rates (in terms of normalized unit labor costs) that have taken place for the seven largest industrial countries since 1974, the first full year of generalized floating.3 In an attempt to remove the effects of short-term volatility, the series charted are five-quarter centered moving averages. For five of the countries, differences between the maximum and minimum values recorded since 1974 were limited to about 20 points on the index. Such changes are clearly large enough to have a major impact on production and investment, yet in each case the swings did prove to be transitory. Without trying to settle the question of the extent to which the changes were “too large,’ suffice it to note that they were perhaps inevitable in a decade of such severe economic shocks as the last ten years—and, at least in some cases, the fluctuations were clearly due to the response of the markets to exogenous shocks rather than to domestic policies. For example, major fluctuations in Japan’s real rates took place following each round of oil price increases. The first round resulted in a depreciation of some 10 percent, the second in one of over 20 percent. In the first instance there was a subsequent recovery to well beyond the previous peak, and there was also some rebound from the low point reached in the second episode. (Average rates for shorter periods moved much more sharply, of course.) These depreciations clearly facilitated the quick recovery of Japan’s balance of payments, but the “overshooting” involved presumably reflected mistaken expectations about the extent and duration of the increase in the real oil prices faced by Japan, and about the flexibility of Japan’s oil consumption and its ability to expand its exports.

Chart 1.
Chart 1.

Real Effective Exchange Rates

(1974 = 100)

Source: International Financial Statistics.Note: Rates are centered 5-quarter moving averages of relative normalized unit labor costs.

The sustained real changes in sterling and the U.S. dollar have been much larger. North Sea oil appropriately led to a sharp appreciation in the real rate for sterling, though the increase of 60 percent that took place between 1977 and 1981, partly in response to domestic restraint, severely exacerbated the problems of structural adjustment in the United Kingdom. In the United States, on the other hand, the appreciation of almost 50 percent since 1979 has been largely the result of unbalanced domestic policies, though the relative attractiveness of the United States as a “safe haven” for investment may also have played some role.4

The appreciation of the dollar reflects a combination of policies that has rarely occurred—an expansionary fiscal policy, with a monetary policy aimed at reducing inflation. High real interest rates result. In a closed economy these would rise enough to crowd out sufficient private expenditure to release the pressure, but the availability of foreign capital in an open economy mitigates the rise in real interest rates. The resulting capital inflow, with flexible exchange rates, must be reflected in a current account deficit. The dollar thus appreciates to the point where it crowds out enough domestic production of tradable goods to accommodate the capital inflow. But just as in the case of more moderate swings in real effective exchange rates, the market seems to have pushed the exchange rate beyond what is needed for external balance. If the rate stays at its present level, it seems likely to result in a much larger crowding out of tradables production than would be needed to accommodate the anticipated capital inflow. The exchange rate may thus depreciate from its current level even if no correction of domestic policies takes place. At some point, of course, rising external debt will choke off capital inflows, and the United States and the rest of the world will have to go through the painful process of reallocating resources consistent with a much smaller U.S. current account deficit.5

If most of the questions raised about floating rates relate to their excessive flexibility, the problem for many of the countries that have not had floating rates has rather been one of insufficient flexibility. Very rarely has the issue of competitive devaluation been raised; rather countries have tended to resist for too long a need for currency depreciation stemming either from adverse external developments or, more frequently, from a loss of competitiveness because of domestic inflation. The rapid growth of international capital markets and of access to them by developing countries facilitated the maintenance of overvalued currencies in the late 1970s. More recently, the changed climate in capital markets has led to more active exchange rate policies for many countries, though the continuation of severe restrictions on external transactions continues to permit severe overvaluation in many cases.6 Nonetheless, the spread of more flexible exchange arrangements means that for many countries the major issue, as in the case of floating currencies, is not so much the question of exchange rate policies but the role domestic policies play in distorting the economic environment. However, for an important subset of such countries, those that have been able to maintain traditional pegs to the U.S. dollar through cautious demand management policies, the erosion of competitiveness as their currencies have risen along with the dollar raises an issue of exchange rate policy that, for them, is new and perplexing.7

Exchange Rate Policies and the Fund

Under the par value system, the responsibilities of members of the Fund with respect to exchange rate policies were to collaborate with the Fund to promote exchange stability, to maintain orderly exchange arrangements with other members, and to avoid competitive exchange alterations. They were not to change the parities of their currencies, except when there was a “fundamental disequilibrium,” in which case they could change the exchange rate after consulting with the Fund. As no clear definition of “fundamental disequilibrium” was provided, countries had considerable latitude, and in practice exchange rates did not show the flexibility that the drafters of the original Articles of Agreement may have expected—which was one factor leading to the ultimate demise of the system. The obligation of prior consultation, moreover, was rarely fulfilled in a meaningful sense—but the actions taken were nonetheless generally considered appropriate, and in practice the lack of consultation did not prove to be a major problem.

With the collapse of the par value system in the early 1970s, there was felt to be an urgent need to develop new principles for the guidance of members’ exchange rate policies to ensure that members did not follow harmful and inconsistent exchange rate policies. As a preliminary step in that direction, in June 1974 the Fund adopted “Guidelines for the Management of Floating Exchange Rates” (Decision 4232–(74/67)). As the title of the guidelines implied, members with floating rates were asked to manage them to some degree. Management was to be aimed at (1) smoothing out very short-run fluctuations in market rates; (2) offering a measure of resistance to market tendencies in the slightly longer run, particularly when they were leading to unduly rapid movements in the rate; and (3) to the extent that it was possible to form a reasonable estimate of the medium-term norm for a country’s exchange rate, resisting movement in market rates that appeared to be deviating substantially from that norm. The role of intervention in exchange rate management was emphasized, but a variety of other techniques that could be employed were also noted, such as, “official forward exchange market intervention, official foreign borrowing or lending, capital restrictions, separate capital exchange markets, various types of fiscal intervention, and also monetary or interest rate policies.”

Four aspects of the guidelines are worth remarking on, if they are considered as a transitional step between the obligations of countries under the par value system and their obligations under the present amended Articles of Agreement. First, the request to each member to avoid substantial deviations from a medium-term norm for its exchange rate was somewhat reminiscent of the “par value” concept, though the fact that this was to be done only to the extent it was possible to form a reasonable estimate of the norm provided a very large loophole. Second, it was noted that, because of fears of competitive depreciation, particular attention continued to be attached to departures from the guidelines in the direction of depreciation. Third, while monetary or interest rate policies were mentioned as possible means of influencing exchange rates, the statement of the guidelines went on to note that “monetary or interest rate policies adopted for demand management purposes or other policies adopted for purposes other than balance of payments purposes would not be regarded as action to influence the exchange rate.” Finally, there was considerable emphasis on exchange market intervention and related measures, at least to the extent of limiting the short run volatility of rates. On each of these points there was to be further development in the process of formulating the Second Amendment and in its subsequent implementation.

The Second Amendment to the Articles of Agreement, which came into effect in 1978, incorporated a revised set of obligations for the Fund and its members on exchange rate policies. The exchange arrangement to be followed was at the discretion of the member, with the specific exclusion of a link to gold, but members were required to declare to the Fund the exchange arrangements they intended to follow. The Fund was required to exercise firm surveillance over the exchange rate policies of members, and members were to provide the information the Fund needed for this purpose and, upon request, to consult with the Fund regarding their exchange rate policies. The Fund was also required to “adopt specific principles for the guidance of all members with respect to those policies.” In the event, the principles eventually adopted (in a decision taken by the Executive Board in April 1977, referred to here as the Surveillance Document), did not try to achieve great precision in specifying members’ obligations, but instead focused on the conduct of surveillance, in particular the kinds of situations that might indicate a need for the Fund to initiate discussions with a member regarding its policies.

Of the four aspects of the guidelines for floating noted above, with respect to the first, the Second Amendment involved a further evolution away from the concept of par values or medium-term norms for exchange rates. The new Articles made no reference to the subject, beyond allowing for the possibility of a return to a par value system at some future date. The Surveillance Document simply noted as one of the five types of developments that might indicate a need for discussions between the Fund and a member “behavior of the exchange rate that appears to be unrelated to underlying economic and financial conditions including factors affecting competitiveness and long-term capital movements.”

On the second aspect, where the guidelines for floating had retained the original emphasis on the avoidance of competitive devaluations, the new Articles explicitly recognized that the general objective of an orderly, stable system could be jeopardized as much by a lack of flexibility in exchange rates as by excessive flexibility. It was now “manipulation” of exchange rates that was enjoined, rather than “alteration,” and manipulation must be avoided not only when it was undertaken “to gain an unfair competitive advantage over other members,” but also where it was undertaken “to prevent effective balance of payments adjustment.”

On the third aspect, the role of domestic policies in exchange rate determination, the new Article IV, in contrast to the original one, did not confine itself to exchange rate policies as such. It noted that, as part of each member’s obligation to “collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates,” each member should “endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances” and “seek to promote stability by fostering orderly underlying economic and financial conditions and a monetary system that does not tend to produce erratic disruptions.” In contrast to the guidelines for floating, moreover, the Surveillance Document pointed to a role for domestic policies, noting that the Fund’s appraisal of a member’s exchange rate policies was to “recognize that domestic as well as external policies can contribute to timely adjustment of the balance of payments,” and was to take into account the extent to which the policies of the member served the general objectives of financial stability, growth, and employment. The Document nonetheless continued to give great weight to exchange rate manipulation as such, with four of the five developments that might indicate a need for discussions with a member falling into this category.

Finally, the Surveillance Document continued to stress the role of intervention, but advocated it only “to counter disorderly conditions,” and cited, as the first of the developments that might indicate the need for discussion with a member, “protracted large-scale intervention in one direction in the exchange market.”

Before turning to the question of the effectiveness of surveillance, it may be useful to consider developments over the last seven years with respect to each of the four aspects emphasized above. There continue to be differences in views between those who maintain that the rate set by the market is right in some fundamental sense, and those who argue that there should be norms against which market behavior should be judged and, if possible, corrected. The experience of the European Monetary System (EMS) has demonstrated that, with sufficient policy determination, a system similar to par values can be maintained. Conceptually, there is some reconciliation of opposing views through the growing emphasis on sustainability of the exchange rate in the medium term. In recent years the work of the Fund has placed much greater emphasis on explicit medium-term scenarios, both at the global level and at the level of individual countries. There has also been considerable attention paid to the concept of competitiveness, and proponents of market forces acknowledge that at some point (though not necessarily soon) market rates and those consistent with competitiveness considerations need to converge.8 Aside from a philosophical attachment to the principles of market determination, however, opponents of norms continue to question whether they can be established with enough precision to be a useful policy tool.

The role of domestic policies has continued to gain prominence in discussions of floating rates, particularly in view of the rise of the U.S. dollar, which is clearly not the result of exchange rate policies as such. There remain strong differences in view with respect to whether or not the exchange rate should be a proximate policy objective in formulating domestic policies, with those opposed not only questioning the feasibility of influencing the rate, but also noting the danger of tying policy to the maintenance of an inappropriate rate.

The third aspect, the question of competitive devaluation, has been raised remarkably infrequently with respect to floating rates. There have occasionally been suggestions that Japan’s financial system has acted to prevent an appropriate appreciation of the yen, but these have not received broad support and the yen, in any case, has appreciated in real effective terms since the end of 1980, the same period in which the U.S. dollar has experienced its remarkable appreciation. Even for countries without floating rates, the issue of competitive devaluation has rarely been raised. The question of exchange rate policies preventing effective balance of payments adjustment has, on the other hand, been a major issue with such countries, particularly developing countries.

Intervention has continued to be the subject of considerable attention. Official intervention has been frequent and substantial, even aside from situations characterized by fixed relationships such as the EMS.9 Nonetheless, there appears to be widespread recognition that given the present scale of exchange transactions, intervention can do little to affect exchange rates except in the very short run, and even then may accomplish little. Proponents of intervention thus do not stress its efficacy as such, but rather as a signal of the determination of financial authorities to resist inappropriate movements in exchange rates; and it is recognized that for that signal to be effective, the market has to be convinced that domestic policies will be adapted accordingly.

The Effectiveness of Surveillance

The Fund’s surveillance responsibilities are much more far-reaching than were its responsibilities under the par value system and imply a more active role for the Fund. Under the former system, a member was required to consult with the Fund regarding its exchange rate policy only when it proposed a change in the par value of its currency, and the Fund’s role was limited to concurrence or objection to the change. The Fund’s obligation “to exercise firm surveillance over the exchange rate policies of members” implies a need to engage in a continuous review of these policies, and the Fund’s appraisal must take account of the extent to which the policies of the member—not just its exchange rate policies as such—are compatible with the objectives set out in Article IV. Thus aside from reviewing exchange rate policies, in recent years Fund surveillance has also emphasized such issues as imbalances in domestic policies, protectionism, excessive external borrowing, and structural impediments to economic adjustment.

Under the par value system, members had an obligation to seek the concurrence of the Fund in proposed exchange rate changes, however, while under the present Articles members’ obligations are limited to consultation. Though in practice this may not have involved any diminution of members’ responsibilities, it does point to an essential weakness in surveillance—that there is no requirement that the Fund and its member countries reach agreement on the appropriateness of actions taken, or not taken.

Surveillance has nonetheless had some successes. At the most general level, there has, as yet, been no major retreat from the progress made since the Second World War in major aspects of economic integration. Indeed further progress toward integration has been made, particularly with respect to financial markets. That this progress has been maintained despite the severe economic strains of recent years is no small accomplishment. Following an initial spurt of inflation, moreover, inflation rates in most countries have come down to levels not seen since before the advent of floating rates. The external debt crisis, if not resolved, has at least been contained.

These positive developments are not necessarily attributable to surveillance alone. Nonetheless, there are numerous examples of countries taking actions in line with the views expressed by the international community, for which Fund surveillance is a major channel. Surveillance can be effective by keeping international economic issues before the eyes of domestic policymakers, which means that international implications are always taken account of to at least some degree in policy decisions.

There have, of course, been unfortunate developments that could be considered only as failures of surveillance. In the late 1970s and early 1980s, one such failure was an inability to prevent many developing countries from taking on too much external debt. And the consequences of that failure were exacerbated by a second major failure of surveillance—the severe imbalance of macroeconomic policies in a number of industrial countries, notably the United States.

There is thus a perennial search for ways to make surveillance more effective. Particular attention is being focused on the issue these days in the meetings of the Group of Ten, where the Deputies are considering proposals on which they plan to report in the near future.10 Ideas for enhancing the effectiveness of surveillance may be listed under five headings.

(1) Analysis. Insofar as surveillance runs into difficulties because of failure to agree on the likely economic consequences, domestic and external, of particular policy actions, better economic analysis can help. In the work of the Fund, as noted above, more attention has recently been focused on the medium-term consequences of current policies, both in the global view taken in the World Economic Outlook and in consultations with individual countries. Quantification of the economic impact of protectionism and the analysis of external indebtedness have also received increased attention.

(2) Supplemental consultations and the role of automatic indicators. Consultation between the Fund and its members is at the heart of the surveillance process, and procedural adaptations in recent years have helped to ensure that consultations take place at regular intervals. Additional consultations could be helpful in some cases where policy problems seem particularly severe. It might also be useful to focus attention on important developments through monitoring selected indicators. Procedures have recently been developed for monitoring real effective exchange rates. More generally, the Fund and member countries could agree to monitor particular indicators, and certain developments in them could lead to supplemental consultations.

(3) The level of involvement of the authorities of member countries. If the main role of surveillance is to keep international economic issues before domestic policymakers, it is important that the latter have the issues brought to their attention as directly and forcefully as possible. Procedural changes to this end could be considered.

(4) Multilateral aspects. Other international organizations besides the Fund play a role in surveillance, and cooperation between them and the Fund has been increasing in recent years. Views expressed by individual countries on the policies of other countries, whether expressed bilaterally or in multilateral forums, also have an effect.

(5) Publicity. Perhaps the most controversial suggestion for enhancing the effectiveness of surveillance is to go beyond the traditional confidential consultation process between the Fund and its members, supplemented by multilateral discussions at the official level, to bring the issues to the attention of private financial institutions or the general public. Ultimately this could lead to more effective surveillance through the involvement of domestic political processes, though the consequences might not always be predictable. Against this would be the inevitable loss in frankness of discussion which confidentiality permits.

Should the System be Changed?

Though some of the ideas noted above do extend surveillance beyond the process of confidential consultation to which it has been limited up to now, they are unlikely to remove concerns about its effectiveness. Perhaps that is all right—it is clearly not totally ineffective, and some might feel that strengthening it much further would lead to unacceptable limitations on national sovereignty.

Many feel, however, that countries should commit themselves more strongly to taking the international interest into account in their policy decisions. That is, they should reach agreement with other countries, preferably under the auspices of the Fund, on the policies to be pursued. Such agreements could be less specific than they were under the par value system (they need not, for example, inhibit shifts in policies within broad limits), but they could also be more wide ranging.

One example advocated in some quarters is the concept of target zones, a term which had appeared in the guidelines for floating. This is not the place for a detailed discussion of target zones. Suffice it to note that with the success industrial countries have had in bringing down their inflation rates, with its associated narrowing of inflation differentials, the idea of more stability in nominal exchange rates than occurred in the first 12 years of floating no longer seems wildly Utopian; but at the same time one of the critical requirements, that the rates for key world currencies be seen as sustainable, is not yet in sight. The crucial element in such proposals, however, is the commitment to adapt domestic policies to keep the exchange rate within the target zone—without that commitment, exchange markets will not accept the plausibility of the zone. In a sense, therefore, the precise nature of the exchange rate system is not important; what is important is the commitment of countries to stable and sustainable policies that take account of both domestic objectives and the international interest.


L.D.D. Price

The paper by Johnson is a useful historical survey, and I agree with several of his conclusions. Floating between the dollar on the one hand and the yen, the deutsche mark, and sterling on the other, was probably inescapable in the 1970s, mainly as a consequence of the greater integration of capital markets. Capital mobility has greatly increased, largely as a result of arbitrage flows; with too few speculators taking positions, exchange rate instability results. Governments, central banks, and international financial institutions have been following rather than causing these developments.

I also agree that floating has been less happy since 1981 than it was in the 1970s. The integration of world capital markets continues—the latest development being interest and currency swaps whereby borrowers turn to the cheapest market for funds and then swap the proceeds into the currency they want. Although it is not clear that the short-term variability of exchange rates has affected trade or investment, longer-term swings must have impeded sensible investment decisions.

I do see a role for central banks taking a view on exchange rates in the medium term. In his second footnote, Johnson suggests that this requires policymakers knowing better than the market that disturbances are transitory. But central banks can play a role, even if their foresight is no better than that of others, if speculators (presumably because they are too risk averse) are unwilling to invest in medium-term speculation. The unwillingness of market speculators to support the sterling exchange rate in the mid-1970s before North Sea oil came on stream is accepted as an example of such risk-averse behavior.

Johnson refers to the majority of countries that have continued to maintain a peg on a particular currency, but because of the floating between major currencies have lost their reference standard. Some countries have pegged to the SDR or especially constructed baskets to reduce unintended effective exchange rate movements, but many still peg to the dollar. Johnson refers to problems for some countries whose cautious demand management policies have been harmed by the latter peg. Such cases exist, although a more common combination is inappropriate exchange rate policies and poor domestic policies.

Floating has certainly not immunized countries from the rest of the world. Those policymakers who thought that floating might remove the balance of payments constraint on their policies were quickly disillusioned. Nor did floating insulate countries from the effects of policies elsewhere. This was already recognized in 1974 when the Fund proposed its guidelines for floating. But as Johnson says, the drafters of the guidelines at that time saw exchange rate policies largely in isolation from domestic economic policies. Countries still hoped to influence medium-term exchange rate fluctuations. The United States, in particular, wished to use objective indicators, such as the basic balance of payments, to demonstrate when a currency was clearly overvalued or undervalued. With memories of 1971 still fresh, the United States wished to protect the dollar from overvaluation; very different opinions now seem to prevail in the U.S. Administration.

The effects of so-called domestic policies on other countries were of course perceived, but governments showed little inclination to agree to guidelines that would recognize their interaction with exchange rates, as they were unwilling to surrender sovereignty over their domestic policies. This unwillingness to agree to change domestic policies in the interests of the system as a whole is the continuing story of surveillance. In practice, surveillance as practiced by the Fund has been more a matter of persuading countries to adopt better policies that are clearly in their own interests, rather than in the interests of other countries.

Some of the recent game-theoretic work on policy coordination suggests that the Fund might be quite right to concentrate on this aspect of surveillance. The conclusions of most of this academic work depend on the specific assumptions of the model, but typically they show that the gains from policy coordination itself would have been quite small and that much bigger gains—in, for example, output—could have been realized if national policymakers had adopted policies that were better for their own economies than those historically pursued. Of course, it is easier to determine optimal policies with hindsight than when facing an uncertain future. But those seeking to coordinate policies internationally are at least as uncertain about the future as domestic policymakers, and there must, in addition, be strong doubts that significant gains from policy coordination can in fact be realized, given uncertainty not only about the future but also about the underlying structure of the world economy which the models have tried to capture. Perhaps, therefore, the Fund is right to concentrate on seeking to persuade countries to adopt policies that are as much in their own interests as in the system’s, although of course it must do this in a framework that formally rejects the obvious beggar-my-neighbor policies such as trade restrictions.

A particular role for the Fund is perhaps in advising countries, in their own interest, to take a longer-term view of their policies. Political pressures, particularly election cycles, can certainly influence national policies in ways which may be seen to be economically undesirable. The need to take a longer-term view of policies can apply to countries of all sizes—indeed, the prime example at the moment must be the United States where policies that were attractive in the short term seem bound to be unsustainable in the end. In cases where the Fund has apparently succeeded in persuading countries to change their policies through surveillance, the countries probably agreed because they saw the policy changes as being in their own interests as well as in those of other countries or the system as a whole.

Is then the Fund’s main role to look at national policies in a national context, but taking a more medium-term view than a national government may? Whatever its role, is it able to overcome the “essential weakness” mentioned by Johnson—that is, the absence of the need for the member and the Fund to agree? And for surveillance to be more powerful, is it necessary for the outcome of Article IV consultations to be considered in national governments at a more senior level—or indeed to be considered in legislatures?


  • Artus, Jacques R. and Andrew D. Crockett, Floating Exchange Rates and the Need for Surveillance, Essays in International Finance No. 127 (Princeton, New Jersey: Princeton University, May 1978).

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  • International Monetary Fund, Exchange Rate Volatility and World Trade, a study by the Research Department, Occasional Paper No. 28 (Washington, July 1984a).

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  • International Monetary Fund, Issues in the Assessment of the Exchange Rates of Industrial countries, a study by the Research Department, Occasional Paper No. 29 (Washington, July 1984b).

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  • International Monetary Fund, The Exchange Rate System: Lessons of the Past and Options for the Future, a study by the Research Department, Occasional Paper No. 30 (Washington, July 1984c).

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  • Johnson, G.G., et al., Formulation of Exchange Rate Policies in Adjustment Programs, Occasional Paper No. 36 (Washington, International Monetary Fund, August 1985).

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Mr. Johnson is Chief of the Stand-By Policies Division in the Exchange and Trade Relations Department of the International Monetary Fund.


International Monetary Fund (1984c) provides a comprehensive review of the experience with the present system. See Artus and Crockett (1978) for a succinct summary of the issues as they were seen at the time the present system was formally recognized through the adoption of the Second Amendment to the Fund’s Articles of Agreement.


Under fixed exchange rates, changes in reserves and, if necessary, changes in domestic policies should take care of transitory disturbances—but this requires that (1) policymakers know better than the market that the disturbances are transitory, and (2) reserves are adequate to support the difference between their perceptions and those of the markets.


The series used are the standard IMF indexes that appear in the table “Cost and Price Comparisons” in International Financial Statistics. There are, of course, a host of conceptual and methodological issues involved in drawing conclusions from such indexes about developments in competitiveness, but they are generally accepted as the best indexes for this purpose.


The frequently heard argument that the flexibility displayed by the American economy and its relatively favorable growth performance in recent years have also made the United States attractive for foreign capital is more difficult to follow. Perhaps what it means is that the real effective appreciation overstates the loss of competitiveness which is in fact occurring. In this context, “flexibility” means that nominal costs in the United States are expected to decline sharply relative to those abroad (through, for instance, downward pressure on wages in flexible labor markets), or that there is more capacity in the United States than abroad to achieve real savings through more efficient use of resources. In either case a given nominal exchange rate would be associated with declining real rates over time.


It is sometimes argued that the strong dollar and the associated U.S. current account deficit help the rest of the world. Perhaps it eases the process of phasing out obsolete capacity in the production of tradable goods in European countries, but at the same time the maintenance of high domestic interest rates by such countries to mitigate the downward pressures on their exchange rates inhibits new investment. Similarly, for developing countries with large external debts, the need to meet high interest payments means that increases in exports come at the cost of domestic consumption. Once the dollar comes down, moreover, there will need in both cases to be a reorientation of production away from tradables.


Johnson et al. (1985) reviews a number of aspects of exchange rate policies in developing countries, with particular reference to Fund-supported adjustment programs.


This issue can arise even for floating currencies, of course. Despite the fact that the Canadian dollar has experienced a real appreciation of some 15 percent during the period in which the U.S. dollar has been rising rapidly, it is the depreciation vis-à-vis the U.S. dollar that has captured public attention and has led to monetary policies to slow that depreciation.


International Monetary Fund (1984b) provides a review of how the medium-term approach and the concept of competitiveness can be used in the assessment of the exchange rates of industrial countries.


The Group of Ten Deputies’ Report on “The Functioning of the International Monetary System” was completed in June 1985.