Abstract
A CENTRAL ISSUE in future monetary arrangements is the role to be played by exchange rate adjustment. This issue has a close bearing on many other aspects of future monetary arrangements. It has a key role in the adequacy of the adjustment process and in the respective contributions of deficit and surplus countries in that process. It partly underlies the issue of convertibility through its effect on the practical ability of the United States to resume its convertibility obligations; and it has consequential implications for appropriate arrangements for reserve creation. In turn, the role to be played by exchange adjustment will be determined not only by the institutional provisions made at the international level but also by the use actually made of such provisions, as a result of policies of national governments and the development of market forces.
A CENTRAL ISSUE in future monetary arrangements is the role to be played by exchange rate adjustment. This issue has a close bearing on many other aspects of future monetary arrangements. It has a key role in the adequacy of the adjustment process and in the respective contributions of deficit and surplus countries in that process. It partly underlies the issue of convertibility through its effect on the practical ability of the United States to resume its convertibility obligations; and it has consequential implications for appropriate arrangements for reserve creation. In turn, the role to be played by exchange adjustment will be determined not only by the institutional provisions made at the international level but also by the use actually made of such provisions, as a result of policies of national governments and the development of market forces.
This paper approaches this broad problem by a general discussion which takes as its starting point the objectives of the exchange rate regime, and goes, on to consider some inferences that follow for the exchange rate mechanism in its main aspects. It concludes with an outline of a possible scheme that is designed to stimulate further discussion.
Developments that have taken place in the 18 months since the issuance of the report of the Executive Directors, The Role of Exchange Rates in the Adjustment of International Payments, have brought a new perspective to the agenda of exchange rate reform. In particular, the present discussion can and must take into account the implications of a positive exchange rate policy on the part of the United States. This brings fully into view the need for the exchange rate regime to reconcile what may otherwise be competing or inconsistent policies on the part of major member countries. This problem was largely hidden in the first 15 years or so after World War II, during which the United States bore the residual impact of adjustment by other countries (and, until the end of this period, sought to promote such adjustment). The problem of mutual consistency of adjustment policies began to emerge when the United States adopted a “positive” balance of payments policy early in the 1960s, but the problem did not express itself directly in exchange rate terms until the U.S. actions of August 15, 1971. In this sense, the “existing system” of exchange rate adjustment—which was difficult to locate even in the 1969–70 discussions—no longer serves as a point of attainable comparison. The system has changed its characteristics in major respects with the growing use made of exchange adjustment and with the growing problem of reconciling active balance of payments policies on the part of all major members of the system.
I. Objectives
The underlying objectives of the exchange rate regime are necessarily related to broader objectives of the international financial system and the international economy. In this sense the best reference point is still to be found in the purposes of the Fund as stated in Article I of the Articles of Agreement. The objectives can be summarized under three heads covering: the adjustment process; promotion of world trade, employment, real income, and economic development; and support for appropriate domestic policies.
1. Adjustment process
The exchange rate regime should help to promote a satisfactory working of the adjustment process. “Satisfactory” implies adjustment of payments imbalances that is (a) not too slow (which would allow imbalances to become embedded or self-aggravating, entailing excessive transfers of resources between countries on arbitrary criteria and necessitating eventual adjustment that may be disruptive both domestically and internationally); (b) not too sharp or sudden (which would entail unnecessary adjustment where payments imbalances were of a transient kind, or unduly heavy adjustment costs where the resource costs of adjustment to large sustained disequilibria can advantageously be cushioned in their initial impact); and (c) distributed among countries in a way that does not leave deficit countries with an excessive part in the initiation of adjustment measures.
2. Trade and income levels
The exchange rate regime should help to contribute to the attainment of progress in the “real” economy, as indicated in the purpose specified in Article I(ii): “To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.” The exchange rate regime should also help to support the elimination of restrictions and the maintenance of a multilateral system of payments.
3. Domestic economic management
The exchange rate regime should help to promote, or at least support, the pursuit of economic and financial policies that contribute to countries’ domestic objectives, as regards both (a) real economic variables and (b) financial variables, notably including the degree of price stability. More specifically, the exchange rate regime should help, as far as possible, to permit individual countries to pursue their chosen policy objectives without disturbance from or to the policies of other countries with different policy objectives. Since such insulation, particularly beyond a certain point, will be partly at the expense of benefits achieved from international integration, the degree of insulation to be provided by the exchange rate regime will be limited by the balance struck between the competing objectives of independence for national policies and the resource gains from international integration. In this paper it is assumed that this balance is struck at a position of limited exchange flexibility.
Instrumental desiderata for attainment of objectives
Attainment of the underlying objectives for the exchange rate regime (enumerated above) suggests a number of instrumental or operational desiderata, which are listed below without regard to potential conflict between them and therefore without consideration of any trade-off among themselves. Such conflict will be discussed in Section II in the context of existing provisions of the par value system. Section III will put forward some possible innovations that are designed to lessen conflicts between the various desiderata.
A. As much exchange stability as possible (for underlying objectives 1(b), 2, and 3).1 Promotion of exchange stability and avoidance of competitive exchange depreciation are listed among the purposes of the Fund, but in economic terms they are clearly instrumental objectives. The criterion of stability will vary accordingly to the time period in view; a small number of large changes occurring periodically are not necessarily to be regarded as offering greater stability than more gradual changes along a smoother path.
B. As much promptness (or as little delay) as possible in needed exchange rate changes (1, and perhaps also 2 and 3). Prompt adjustment should help to avoid the cumulation and aggravation of disequilibria and associated distortions in domestic economies. It is sometimes feared that prompt exchange adjustment will have perverse effects where the national authorities find it politically more feasible to implement desired domestic policies (and specifically, anti-inflationary policies) on the basis of an unchanged parity. But insofar as delays in exchange adjustment increase the size of the needed adjustment and the associated transfer of resources, they may aggravate future inflationary pressures. Prompt exchange adjustment should also contribute to the success of counterinflationary policies in surplus countries.
C. As much smoothness (or as little jerkiness) as possible for those exchange adjustments that take place (for objective 1), in the sense of avoiding large forced movements in market rates. Two separate desiderata are involved here: (i) the desirability of minimizing short-term capital flows that are destabilizing in the sense that they increase official imbalances that have to be financed by reserves or credits (and that in the context of exchange adjustment involve exchange losses by the official sector and corresponding gains by the private sector); and (ii) the desirability of limiting the size of exchange adjustment from the domestic standpoint, to avoid unduly sharp cost effects and resource shifts (as mentioned under B). Admittedly, the optimal path of adjustment is unlikely to be the same from these two standpoints. Thus, limitation of destabilizing speculation will call for minimizing the size of forced and predictable movements in market rates, which will call for expected movements in parities in steps that are small in relation to the size of exchange margins but that are nonetheless adequate in the context of the evident disequilibrium to be dealt with by exchange adjustment. This in turn will call for some combination of timely parity adjustment, limitation of the size of disequilibria to be dealt with by parity adjustment, and width of exchange margins. But the pattern of movement in exchange rates and parities needed to maintain minimum exposure to destabilizing speculation could involve adjustment of market exchange rates in a process that is slower than that needed for the purpose of avoiding disruptively sharp effects on domestic prices and resource shifts; an unduly slow movement of the market rate, or an unduly erratic movement around the trend, could instead induce insufficient shift of resources.
There may also be times when large disequilibria arise suddenly, and an early once-for-all exchange adjustment may be preferable to a smoother adjustment drawn out over time. However, in recent times, payments disequilibria in industrial countries have arisen gradually rather than suddenly, and large exchange adjustments have been necessitated by delayed response to accumulating disequilibria rather than by the sudden emergence of large disequilibria. Perhaps the only exception, in the period since the move by European countries to convertibility at the end of 1958, might be that of France in May-June 1968.
D. Minimum friction in implementation of exchange adjustments by actions of national and international authorities (1,2,3). The clearer the signal for exchange adjustment, and the clearer the responsibility of particular countries for initiating such adjustments, the greater the prospects that adjustments of the kind suggested by considerations B and C will be carried out without mutual conflict. At the same time, the provisions for international validation of exchange adjustments need to give adequate protection to the legitimate concerns of countries other than those that initiate the adjustment.
E. Avoidance of large divergences of exchange rates from long-term equilibrium rates. This instrumental desideratum is in part encompassed in those discussed above, but it is listed separately on the view that avoidance of such divergence beyond a certain threshold should be considered as an instrumental desideratum in its own right. On this view, a divergence of x per cent, where x is larger than the threshold, would be more damaging to the underlying objectives than two divergences of ½x. Or, to put it another way, small divergences from equilibrium exchange rates are of limited significance, as reflected in the difficulty of measuring them: the tolerances and interrelationships involved are such that an economy adapts fairly smoothly to any exchange rate within a range of a few percentage points of the optimum or equilibrium exchange rate. By contrast, adaptation to an exchange rate outside such a range, and especially to a rate diverging progressively from equilibrium, is likely to involve substantial frictions. On this view, to have exactly the right exchange rate is not only unattainable but not particularly important. What is important is to be sure of avoiding a manifestly wrong exchange rate.
II. Implementation Under Existing Provisions
It is evident that no exchange rate regime can meet all the operational or instrumental desiderata noted above; the problem is to find the system offering the best balance between them.
The legal regime under the existing Articles of Agreement of the Fund may be summarized as follows. Member countries establish par values and agree to limit fluctuations in market spot exchange rates within 1 per cent on either side of the par value. Since 1959 this requirement has been interpreted, with some technical qualification, as the permitted fluctuation vis-à-vis the intervention currency; and since the Smithsonian agreement of December 18, 1971, a margin of 2¼ per cent has been permitted under an extralegal arrangement. Changes in par values under the Articles may be made only on the proposal of the member, and after consultation with the Fund. For such changes as do not exceed 10 per cent together with all previous changes in the member’s par value regardless of sign, the Fund is not entitled to object; for all other changes, the Fund may concur or object within a specified time dependent on the size of the change—again measured cumulatively from the initial par value.
The circumstances under which par values may be changed are referred to in a single key sentence of the Articles: “A member shall not propose a change in the par value of its currency except to correct a fundamental disequilibrium.” 2 The negative formulation of this provision, establishing when a par value should not be changed, but not when it should be, is a true reflection of the essentially passive, screening role allotted to the international community in exchange rate matters under the compromise that emerged at Bretton Woods. According to the letter of the Articles, the criterion of fundamental disequilibrium could also have been interpreted restrictively. In practice, a restrictive interpretation has been avoided. In 1970 the liberal interpretation of fundamental disequilibrium was made explicit in the exchange rate report of the Executive Directors, as indicated in the following passage.
A basic feature of the concept of fundamental disequilibrium is that although its ultimate focus is on the balance of payments it is related to a general condition of the member’s economy and does not require that an imbalance must have developed in the balance of payments. This, in turn, reflects the underlying philosophy of the Bretton Woods system that while attainment of balance in international payments must be a focal point of concern for the international financial community, it is not to be regarded as an objective in isolation from other objectives of the international monetary system. These objectives include the expansion and balanced growth of international trade on the basis of a liberal and nondiscriminatory regime of trade and payments, to contribute to the promotion of high levels of employment and real income and to the development of the productive resources of all the Fund’s members as primary objectives of economic policy.† In this conception, attainment of payments balance through the use of measures destructive of national or international prosperity would clearly not comprise a durable payments equilibrium.
Thus, the criterion of fundamental disequilibrium is wider than the occurrence of a disequilibrium in the actual balance of payments, as measured by movement in reserves and the probable accompanying movement of the market rate of exchange within the band around parity. 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. 3
As has been pointed out occasionally in the past, the provisions on exchange adjustment in the Fund’s Articles (which were not affected by the 1969 Amendments) may entail very different operative exchange systems according to the prevailing circumstances and the desire among member countries to activate their option to change their parity in conditions of fundamental disequilibrium. Thus, depending on the attitudes and situations of member countries, the provisions are consistent with something close to a fixed rate system—as the par value system was occasionally interpreted by some member countries in the 1950s and early in the 1960s; the provisions are also consistent with more frequent adjustment of parities, and this may exclude or include parity adjustment by reserve center countries. A system based on the most flexible use of parity adjustment will differ greatly from a system approximating fixed rates, and, as will be suggested, it may tend to gravitate either toward greater flexibility in institutional provisions or back toward fixity. If the underlying circumstances are such that fixity of rates involves serious strains on members’ economies, then this latter path may merely postpone exchange adjustment, so that in these circumstances the parity system, or adjustments made outside the system, will be inconsistent with a fixed rate system over time.
A system of adjustable parities and narrow margins should score well on the objective of exchange stability, provided that the adjustments are not too large or too frequent. The system allows exchange parities to be used as a fulcrum for certain other policies, and some countries have found defense of their parity to be a help in mobilizing political or administrative support for restrictive fiscal measures and for incomes policies. On the other hand, a restrictive monetary policy may be impeded by fixity of the exchange rate.
In principle, the system of adjustable parities and narrow margins also permits avoidance of large divergences of exchange rates from their long-term equilibrium level. On the other hand, in the past operation of the system, parity adjustments have not been prompt (in relation to the disequilibria that they are intended to deal with). This has, in part, reflected the contemporary attitudes of major countries, and specifically of reserve center countries, toward exchange adjustment. A change in these attitudes, such as has been evident over the past five years or so, can be expected to reduce delays in parity adjustments to some extent. However, progress in this direction is likely to be limited in practice by the fact that delays in parity adjustment do not merely reflect misjudgment but can contribute in certain circumstances to such objectives as exchange stability and mobilization of support for unpopular domestic measures. Moreover, where the scope for variation of market rates around parity is not larger than the margins permitted under the Articles, the prospect of even relatively small parity changes is likely to entail destabilizing speculation; and a history of past parity changes, and of the associated speculative gains to the private sector, is likely to increase the amount of speculation associated with apparent disequilibria of a given size (as may well have been happening in recent years).
Equally, adjustment of parities at an early stage of disequilibrium will normally make it more difficult to establish the correct size of adjustment; and where events develop differently from anticipations, the original adjustment may need to be reversed. It follows that more prompt adjustment of parities would in practice be likely to entail more frequent adjustment, including occasional reversals of earlier changes after fairly short intervals. Adjustment in this way would, however, tend to strain the concept of parity adjustment to deal with fundamental disequilibrium, even in its liberal interpretation. The speculative pressures that such practices of more prompt, more frequent, and more “two-way” parity adjustment might involve might well be smaller rather than larger than the pressures involved in occasional parity adjustment in steeper steps; but it would be desirable to reduce these pressures under any method of parity adjustments by means of a widening of exchange rate margins. The considerations involved were discussed fully in 1970 in The Role of Exchange Rates.
Another consequence of parity adjustment other than in the rigid variant is that implementation of such adjustment may be impeded by imprecision of signals and of assignment of responsibility for initiation of such adjustment. This problem first became evident in the European exchange crisis of November 1968, culminating in the Bonn conference, when the major evident disequilibrium was between the surplus position of Germany and the deficit position of France, allowing intense and, for many months, unresolved dispute about the apportionment of corrective action between revaluation of the deutsche mark and devaluation of the French franc—an apportionment in which other countries had a direct interest. A partly similar problem re-emerged on a wider front in 1971, in relation to the correction of the maladjustment between the United States and the rest of the world. This recent episode demonstrated with new force that movements in exchange rates in the sense in which they concern national authorities—that is, in the spread of exchange rates vis-à-vis their trading partners and competitors, as expressed in the concept of the effective exchange rate 4—are the result of parity adjustments made by other countries as well as of adjustments in own parities.
In a general realignment of this kind, the distinction usually made between a change and no change in a country’s parity, or indeed between revaluation and devaluation, becomes lost in the multiplicity of relative currency changes, with their reciprocal effects. 5 In such situations, international concern over exchange rate actions of national authorities can clearly not be confined, as it formally is under the Articles, to validating such changes in parities as are proposed by member countries. In practice, international consultation and action has then been extended on an informal basis to the parities and effective exchange rates of all major countries, in relation to their estimated equilibrium level. But no clear-cut basis has been available for assigning responsibility for initiating exchange adjustment among the various countries concerned; this lack may have contributed somewhat to the delays in initiating such adjustments.
In sum, active resort to par value adjustments by major countries, in a regime of narrow margins, gives rise to the following problems, which have been illustrated by the experience of the past few years: (1) near-term stability of exchange rates may conflict with stability over a longer term; (2) destabilizing movements of short-term capital are likely to be large and may gain cumulative force as par value adjustments recur; and (3) implementation of parity adjustments may entail extensive negotiation among major countries concerning their actions or nonactions on their parities, involving the development of an international view on the appropriate level of national parities, i.e., going beyond the provisions of the Articles for international validation of proposals for parity changes made on the initiative of the member country. While such occasions have been the exception rather than the rule in the past 25 years as a whole, they seem unlikely to remain the exception in conditions in which all major countries have active balance of payments policies and in which exchange adjustment plays an important role in implementing such policies.
These problems suggest that operation of the par value system in circumstances in which parity adjustment is needed for major countries on a significant scale may call for certain institutional modifications designed to contain the ensuing problems. The discussion in the next section is based on a combination of two such possible modifications: (1) a widening of exchange rate margins and more frequent adjustment of parities in such a way as to reduce the predictability of movements in market rates associated with parity changes; this involves a concept of exchange stability in a longer time period, implying smoothness of adjustment rather than maximum stability in the near term; (2) a change in the formal basis of international surveillance over exchange rates, from validation of proposals for parity changes to international surveillance over the level of the parity in relation to its estimated equilibrium range. These modifications are designed to improve the performance of the system with the underlying objective of securing adequate and appropriately distributed adjustment, and with such instrumental objectives as (a) smoothness and promptness of adjustments, (b) provision of a working, international mechanism for multilateral adjustment, and (c) avoidance of large divergences from equilibrium rates.
This amounts to saying that the par value system, without institutional modification, is not itself a stable system in circumstances in which fixity of exchange rates is not attainable, or attainable only at excessive cost in terms of underlying objectives. In such circumstances, adjustment of parities under existing institutional arrangements sets off pressures and disturbances that may lead to a variety of alternative outcomes, viz., (1) an attempted return to par values in the fixed variant, entailing an accompanying risk of future breakdown, with exchange flexibility then being attained “outside” the system; or (2) periodic or general abandonment of the par value system, entailing resort to some system of fluctuating exchange rates; or (3) attempts to maintain both the parity system and its flexible operation by modification of institutional arrangements. Section III discusses the kind of institutional modifications that may be involved in this latter course.
III. A Flexible Parity System
The crawling peg
The pressures referred to at the end of the last section in operating the parity system in circumstances in which adjustments of major currencies are needed have given rise to a variety of proposals for modification of present institutional arrangements. These include the proposals under the general heading of the crawling peg. The common objective of these proposals has been to facilitate more flexible adjustment of exchange rates while avoiding certain difficulties associated with parity adjustment under existing arrangements, and at the same time to retain safeguards against excessively large fluctuations.
The various crawling peg proposals share the following main features: 6
(1) Limitation of the maximum size of parity change, involving a maximum annual rate of change, perhaps also expressed in terms of maximum monthly or weekly changes; these provisions relate to the normal regime, provision usually also being made for larger changes in exceptional circumstances.
(2) Implementation of parity changes through streamlined procedures and usually also on the basis of objective criteria, although under some proposals parity changes up to the permitted annual maximum are to remain entirely at the discretion of the national authorities. The objective criteria for the initiation of parity changes include such indicators (sometimes in combination) as (a) an average of past market exchange rates (spot and sometimes also forward); (b) past or current reserve movements; (c) other balance of payments data; (d) domestic economic data relating to competitiveness, such as relative price movements.
(3) The proposals vary in the degree to which these criteria should trigger parity changes automatically, or rather, leave a degree of discretion to national or international authorities; in the latter case, they have sometimes been regarded as presumptive indicators for change.
As indicated earlier in this paper, no exchange rate system that has been tried or suggested is free of drawbacks. The most evident drawbacks in the crawling peg family of proposals, from the standpoint of the principles underlying the par value system, may be summarized as follows.
(1) To the extent that the specified criteria activate parity changes automatically, they would (a) relate such changes to indicators of the balance of payments alone, without regard to the state of the domestic economy and of attainable policy objectives, which are of central importance for the concept of exchange rate equilibrium as related to the equilibrium of the economy as a whole 7 (or, if domestic indicators were added, they would involve composite indicators of great complexity); and (b) permit countries to avoid undesired parity changes by suppressing balance of payments disequilibrium so as to prevent the latent disequilibrium from showing itself in the indicators that trigger the parity changes.
(2) To the extent that the parity changes remain discretionary, with or without specified criteria, the impetus to making changes on the basis of emerging disequilibria may be insufficient, so that parity adjustment may continue to be delayed until disequilibria have become obvious and large—by which time small parity changes will no longer suffice. If national authorities became more ready and willing to make parity changes—and such a change in official attitudes might be promoted to some degree by the new system of parity adjustment—then the force of this limitation, as well as of (l) (b), would diminish correspondingly.
The remainder of this paper explores the way in which the objective of this set of proposals—of facilitating more flexible adjustment of exchange rates on a controlled basis by means of a new institutional mechanism—might be attained at least in substantial part without the limitations indicated above, and, more specifically, while retaining the essential concept of exchange rate equilibrium that underlies the Articles of the Fund and the recent practices of major member countries. This approach in turn could involve limitations of a different kind. It is put forward in this paper as an alternative basis for a flexible parity system, offering a different balance of advantage and possible disadvantage, in a system that is substantively more akin to past practice; it is not the intention of this paper to weigh the net balance of advantage between these alternative approaches.
The most important respect in which this alternative approach to a flexible parity system would differ from the crawling peg proposals already discussed would be that parity changes would continue to be related to developments and prospective developments in the economy as a whole, and therefore would continue to require analysis rather than being solely based on or guided by balance of payments indicators, such as reserve movements or market exchange rates. This feature implies the continued necessity for the exercise of judgment and initiative on the timing and size of parity changes. This in turn raises the question of how this judgment and initiative is to be apportioned between national authorities and international bodies—a question that arises less prominently in crawling peg proposals of the more “automatic” variety. The analysis in earlier sections has suggested that the formal basis of apportionment in the Articles—with initiative to propose parity changes resting exclusively with national authorities, the role of the international community acting through the Fund being the negative or passive one of scrutinizing proposals for their compatibility with international objectives—is excessively limited once the facility for parity adjustment is used at all extensively by major countries. This has been reflected in the more active international role in exchange rate adjustment that has developed through informal arrangements.
A framework for more flexible parity adjustment consistent with the principles mentioned above is likely in any case to involve a further development of this tendency for the Fund to play a more active role in this sphere. Just as simultaneous adjustment of parities by large amounts has necessitated an extension of international surveillance to the parities of all major countries on the basis of their estimated equilibrium level, so this would become necessary in a more continuous process of parity adjustments by small amounts on the part of major countries, in order to safeguard the position of countries other than those initiating the adjustment.
The extent to which the Fund could move to a position of “active parity surveillance” on a more continuing basis is in part a technical question—since such continuing surveillance would make heavy demands on techniques of calculation of equilibrium exchange rates for many countries simultaneously. Another facet of the question concerns the attitude of member countries on the exercise of such initiative by the Fund on a continuing basis. On this latter question, it is important to note that a net loss of control by national authorities over their exchange rates need not necessarily follow from a development along this line. Thus, much would depend on the scope given for taking account of countries’ policies and objectives in estimating the equilibrium exchange rate in the light of these policies and objectives. Equally, provision could be made, if desired, for the scope for national discretion over parities to be made greater than it is at present within a certain range or zone, which would be in the vicinity of the estimated equilibrium rate. It may be recalled that the basic international limitation on the control by individual countries of their effective exchange rate arises from the reciprocal nature of the exchange rate relationship. It follows that an increase in formal international surveillance, by providing additional safeguards against disruptive influences arising from the actions of individual countries, will at the same time provide additional scope for the exercise of national discretion within a limited sphere.
Because of the technical problems relating to the estimation of equilibrium parities, and a possible desire to move gradually and experimentally toward a modified basis of international validation of exchange rates, moves in this direction may in practice take place informally and tentatively. But to give shape to pragmatic developments along this line, it is useful to have in mind the eventual regime that offers a viable basis for a flexible parity system consistent with the “analytical” concept of exchange rate equilibrium and that can therefore be regarded as an effective alternative to regimes involving greater or lesser reliance on fluctuating rates or automatic parity adjustment. The scheme put forward below is presented in that spirit.
Broad outline of a possible scheme
While the scheme retains the underlying principles of the parity regime, it involves a substantial institutional change in implementation. This is designed to provide the necessary institutional framework for operation of the parity system in its more flexible variant, so as to avoid or minimize the risk that the system will be abandoned periodically by major countries through recourse to fluctuating rates. The essence of the scheme is to leave a substantial area of national discretion in establishment of parities and to streamline international procedures for changes in parities within this range of national discretion, but to provide stronger and more institutionalized international pressures against exchange rates becoming manifestly out of line—whether such divergence involves a change in a country’s own parity or not. The scheme thereby also provides a framework in which small and frequent changes in parity would be facilitated and encouraged. Since the scheme also encompasses a widening in exchange margins, such as 3 per cent against the intervention currency, more frequent small changes in parities would not necessarily involve greater fluctuation in market exchange rates.
The scheme would be confined to the major countries for which exchange adjustments had significant effects on the system as a whole. It is assumed that any adverse effect of more flexible parities on developing countries would be taken into account in arrangements outside the exchange rate system.
The scheme has the following main features.
(1) Member countries would continue to have par values expressed in terms of gold or SDRs. In this paper it is assumed, for purposes of exposition, that exchange rates would continue to be maintained in relation to parities by intervention against the common intervention currency.
(2) Exchange margins would be widened, by a limited amount, from the 1 per cent permitted in the Articles; in the illustration that follows, this margin is assumed to be widened to 3 per cent in terms of the intervention currency. The scheme could also operate in the context of different techniques of exchange intervention, for example, multicurrency intervention on a symmetrical basis.
(3) For each country covered by the proposal, an “equilibrium parity zone” 8 would be established. Within this zone, parities would automatically qualify for authorization by the Fund, and parity changes could be made on the decision of the member by notification to the Fund. This zone would be designed to cover the range within which a parity established by the member could reasonably be regarded as consistent with equilibrium in its balance of payments, allowing for (a) foreseeable economic developments as a result of the business cycle and any other predictable influences, (b) national policies and policy objectives that could realistically be expected to influence the balance of payments in the prospective period, and (c) the uncertainties in the precise working of all these influences.
(4) The equilibrium parity zone would be reasonably broad in size, to give sufficient leeway for the exercise of national discretion and to allow for the degree of approximation inherent in the estimation process. For purposes of illustration, it is assumed that the zone would have a standard width of 10 percentage points (that is, 5 per cent on either side of the central point), although a narrower zone might be appropriate for exceptionally large economies, such as the United States.
(5) As indicated in (3), parities of member countries within the zone would automatically qualify for authorization by the Fund. Member countries would be free to change their parities on notification to the Fund as long as their new parity fell within the equilibrium zone. For parity changes within the zone, the member would not need to represent a fundamental disequilibrium, since the concept would be that the whole zone represented a range of equilibrium for the member’s parity.
(6) (a) For each country, the zone would be established at periodic intervals in accordance with the procedures discussed under (7). A member’s parity could therefore fall outside the zone as a result of either (i) a change in the parity to a point outside the zone limits, or (ii) a shift in the zone as a result of the various influences acting on the member’s actual and prospective balance of payments. Such influences could include, inter alia, the effect of changes in parities by other countries.
(b) Members would generally be expected to prevent their parities from falling outside the equilibrium zone, either by taking the appropriate action on their parities or by taking action outside the exchange rate sphere (for example, through monetary or fiscal policy) of a kind that had sufficient influence on the prospective balance of payments to shift the equilibrium parity zone to a position that covered the member’s parity. Whenever a member’s parity fell outside its equilibrium zone, it would cease to qualify automatically for approval by the Fund. The member would then have a parity not authorized by the Fund and, following the provisions of Article IV, Section 6, would be ineligible to use the Fund’s resources. This would be a deterrent to deficit countries but would normally have little influence on countries in strong payments positions. It would therefore be desirable to introduce an equivalent sanction, designed to be painful rather than shameful, to affect surplus countries. Consideration could be given in this respect to withholding allocations of SDRs, and possibly also to limitation of interest payments on SDRs. These questions would require separate consideration. It should be remembered in this context that the provisions for regular repletion of world liquidity in the desired amount through a technique such as allocation of special drawing rights has removed one traditional asymmetry in the adjustment pressures affecting surplus and deficit countries.
(c) Sanctions of such form, or of such other form as was considered appropriate, would normally be invoked if a member had a parity not authorized by the Fund. However, the Fund could be given some leeway to decide to authorize, or in some other way to endorse, a parity outside the equilibrium zone in exceptional cases. As a general principle, it would be desirable to do so only where the member was able and willing to provide assurances of an objective character that the parity would not involve an actual disequilibrium. Such assurances could relate, for example, to commitments on minimum or maximum reserve levels and on policies on payments restrictions.
(7) The zone would be established at periodic intervals, for example, six months, on the basis of consultations between the Fund and the member and of discussions and calculations undertaken by the Fund in a multilateral framework. The focus of this exercise would be calculations of the kind that formed the basis of the recent realignment. Thus, the calculations, which would be in terms of a central point for the equilibrium zone, would be on a rolling basis, being revised in the light of new information on the circumstances and policies of member countries. Consultations with member countries, as well as informal contacts, would play an important part in providing the input for the exercise. The final formulation of the equilibrium parity zones would be the outcome of a high-level multilateral review, for example, in a body such as the Executive Committee of the Board of Governors, which has been mooted.
(8) Formulation of the equilibrium zones would be carried out simultaneously for all the countries concerned, at the periodic intervals; in addition, revisions would be necessary at any time that parities of major countries were changed by a significant amount, or that the parity of a country moved or remained outside its equilibrium zone.
(9) The starting point of the formulation would be a set of indicated adjustments in payments balances, leading on to indicated adjustments in relative exchange rates. In order to derive from these indications a set of central points for equilibrium parity zones, a general rule would be followed. Such a rule might be that upward changes in these central parity points should be balanced, on a weighted basis, by downward changes. This would provide a determinate basis for the transformation of relative exchange rates (or, more strictly, permissible exchange rate zones) into parity zones. It would also have the important effect of putting equal pressure for parity adjustment on surplus and deficit countries. The rule could also, in principle, be formulated to give a different balance, or the rule could be changed from time to time, provided that a definite rule was applicable at the time of the periodic exercises.
Illustration
The working of such a system is illustrated in Chart 1. In the initial period (period I) it is assumed that the equilibrium parity zone—the shaded area—for the country in question is 95–105, and that the central point then coincides with the parity established by the country, at 100. At the time of the next periodic review (period II) it is assumed that consultations and calculations conducted as part of the multilateral exercise establish that the underlying balance of payments has strengthened, so as to raise the equilibrium zone by two points, to 97–107. The parity is unchanged at 100 and still lies within the zone. The national authorities could at this stage depreciate by up to approximately three points, 9 or appreciate by up to seven points, on notification to the Fund, and still qualify for automatic authorization of the parity; the example assumes no change. At the next review (at period III) a further strengthening of the underlying payments position raises the zone a further four points, to 101–11. This brings the parity outside the zone and obliges the country concerned to appreciate in order to qualify for automatic authorization; the assumed appreciation of two points, to a parity of 102, leaves the parity close to the lower limit of the zone.
Illustrative Adjustment of Zones and Parities
Citation: IMF Staff Papers 1972, 002; 10.5089/9781451947373.024.A001
Illustrative Adjustment of Zones and Parities
Citation: IMF Staff Papers 1972, 002; 10.5089/9781451947373.024.A001
Illustrative Adjustment of Zones and Parities
Citation: IMF Staff Papers 1972, 002; 10.5089/9781451947373.024.A001
The chart also shows, in the hatched area, the range for movements in the market rate around the parity. In the example given, the margins of the new parity “overlap” the preceding ones, necessitating no jump in the market rate at the time of the parity change. Of course, this need not be so—that is, a jump may be necessarily implied—in the event of larger movements in parities. (For countries other than the United States, a jump in market rate could also occur as a result of a change in the U.S. parity.) At period III in the example, the market rate could move beyond the equilibrum zone, which relates only to the parity.
Appraisal
A system of this kind, provided that it was operated in the intended manner (see below), could offer a number of possible advantages.
(1) It would, by definition, avoid the emergence of large or growing divergences in exchange rates from their estimated long-term equilibrium.
(2) It would provide special encouragements to countries to initiate moderate exchange adjustments in line with an emerging trend, since such action would preserve a leeway of discretion to national authorities over their parities and would avoid subsequent “forced” changes in those parities at the limits of the equilibrium zone.
(3) It would provide clear signals for adjustment, not necessarily limited to exchange adjustment and evenly distributed between deficit and surplus countries, while retaining a moderate measure of discretion for national authorities.
(4) A further effect, which could be considered advantageous, is that the system would focus the work of the Fund, and of Fund consultations with member countries, still more closely on the external impact of countries’ policies and on the need to achieve international consistency in such policies in a nonrestrictive way.
(5) The system could also be of substantial help in limiting speculative problems. Small parity changes could be made with minimum formality (always within the equilibrium zone) before the existence of a disequilibrium requiring exchange adjustment appeared certain or even highly probable: if the initial change subsequently turned out to be unneeded, or in the wrong direction, a change in the opposite direction would follow. A pattern of this kind, in the context of the wider margins, would greatly reduce the scope for “one-way” speculation. At the same time, it need not entail a corresponding fluctuation in market rates; the connection between parity changes and market rates would become less close.
These advantages could, however, be expected only if the system were operated in a manner reasonably close to that indicated here. Otherwise, the system could involve a balance of disadvantage. Thus, if member countries were not willing to effect small changes in parities, disequilibrium could again build up cumulatively. The system would also then tend to involve frequent or near-continuous international pressures for exchange rate action, and because these pressures were explicit in character, they might appear excessive (the actual pressures might well not be larger than under the existing system). Also, if member countries resisted the guidelines for their parities and had frequent recourse to unauthorized parities, the authority of the Fund could suffer. The appropriate point of comparison for such a possibility is the practical feasibility of maintaining the Fund’s effective authority over exchange adjustment, while securing an adequate working of the international adjustment process as a whole, under the existing regime or other alternatives.
The extent to which a system based on this proposal would represent a substantial rather than an institutional change over the existing regime of the Articles is a matter of debate. As was seen in the recent realignment, industrial countries can presently be more or less forced by international pressures into exchange rate changes of quite substantial amounts. These episodes have also emphasized that formal reservation of a change in a country’s parity to the initiative of national authorities is insufficient protection for national control of the exchange rate in its economic sense—that is, of the effective exchange rate—when other countries are making active use of their right to change their own parity.
In these circumstances, as recalled earlier in this paper, the international concern over parity changes that is essential to avoid mutual conflict has naturally spread to a concern with the position of the exchange rate of each major country in relation to its equilibrium level: the formal power under the Articles to confine a permitted change to a situation of fundamental disequilibrium is no longer enough to fulfill the intended purpose.
The possible scheme put forward above is an attempt to incorporate this broader approach into regular parity arrangements. It thereby aims to make changes in parities less traumatic, both domestically and internationally, and to reduce the risk that exchange adjustments will take place outside the parity regime.
If a proposal of this kind is considered to involve an undue extension of international initiative, at least on a regular basis, the question arises of the effective alternatives. For the reasons indicated in Section II, it seems doubtful that the parity system without some institutional modification would be consistent with the degree of exchange adjustment that seems likely to be required to secure adequate performance of the international adjustment process as a whole. The effective choice may therefore be between the following.
(1) Some modification of the parity system to provide for the exercise of international initiative in a systematic way. The scheme outlined above is an example of a formal arrangement to this end. Less formal arrangements to the same end, involving the exercise of greater international initiative in prompting exchange adjustments and in assessing their multilateral impact, should offer some of the same benefits as the more formal scheme, provided that they are also accompanied by the necessary adaptation in attitudes of member countries toward prompt initiation of parity adjustments. This shift in attitudes effectively requires that parity changes become a matter of routine.
(2) An alternative institutional modification of the parity system in the direction of automatic adjustment in response to market or balance of payments indicators. Adoption of a flexible parity system of this kind, as argued in this paper, would represent a more substantive change from present arrangements than the proposal put forward above for the systematic international guidance of national parity decisions; but the institutional implications are significantly different, leaning to a greater extent on market pressures and dispensing with, or minimizing, both national and international judgment on parities as such.
(3) An essentially unmodified parity system subject to periodic suspension or breakdown, which might in turn gravitate toward an explicit system of fluctuating rates but would meanwhile reopen the question of the future of the system on the occasion of each departure by major countries from the parity regime. The main problem posed by a fluctuating rate system would be to achieve agreement on appropriate rules governing exchange market intervention so as to avoid mutual conflict. The main problem in establishing such rules would be not so much technical as political: an internationally managed fluctuating rate system would require, in the same way as and possibly to a greater degree than modified parity systems under (1), the extension of international surveillance over matters traditionally within the ambit of national authorities. The possibility of avoiding these problems through a system of freely floating rates does not need serious investigation, in conditions in which national authorities are increasingly tending to intervene directly in the formation of prices of far less central influence in their economies than their exchange rates.
Le régime des taux de change : analyse et projet de plan de réforme
Résumé
Le rôle qu’est appelé à jouer l’ajustement des taux de change est l’une des questions qui occuperont une place primordiale dans les futurs accords monétaires. La présente étude examine les objectifs du régime des taux de change, certaines des inferences qui en découlent pour les principaux aspects du mécanisme des taux de change et un nouveau plan grâce auquel on pourrait éventuellement introduire, dans le cadre du système des parités, le degré de flexibilité nécessaire.
Un recours actif, par les principaux pays, à des ajustements du pair de leur monnaie dans un régime de marges étroites, donne naissance aux problèmes ci-après que l’expérience des quelques dernières années a illustrés : a) la stabilité à court terme des taux de change peut se révéler incompatible avec la stabilité à plus long terme; b) les mouvements déséquilibrants de capitaux à court terme seront vraisemblablement importants et peuvent acquérir une force cumulative à mesure que les pays procèdent à de nouveaux ajustements de leur pair; c) la mise en application de ces ajustements peut entraîner de longues et difficiles négociations entre les grands pays – en ce qui concerne leur intervention ou, non-intervention au sujet de leurs parités – nécessitant la formulation d’un point de vue international sur le niveau approprié des parités nationales, autrement dit, débordant le cadre des dispositions des Statuts du Fonds relatives à la validation internationale des propositions de modifications de parités faites sur l’initiative du pays membre. Sans modification institutionnelle, le système du pair n’est pas en soi un système stable dans les cas où la fixité des taux de change n’est pas réalisable, ou ne peut l’être qu’à un prix excessif par rapport aux objectifs de base.
Ces pressions ont suscité toute une variété de propositions tendant à la modification des arrangements actuels, et notamment quelques-unes relevant de la rubrique générale de la parité rampante. Ces propositions ont pour objectif commun de faciliter un ajustement plus souple des taux de change tout en évitant certaines des difficultés liées à l’ajustement des parités dans le cadre des dispositions en vigueur, tout en maintenant des garanties contre des fluctuations d’une ampleur excessive.
Le plan indicatif présenté dans cette étude offre une autre façon d’aborder la question de la flexibilité du système de parités. Il vise essentiellement à laisser aux pays un degré important de latitude pour fixer leurs parités, et à uniformiser les procédures internationales régissant les modifications de parités à l’intérieur de cette marge de latitude nationale, mais aussi à exercer des pressions plus fortes et plus institutionnalisées sur le plan international pour éviter que les taux de change ne s’écartent manifestement de la norme – que cette divergence entraîne ou non une modification de la propre parité d’un pays. Ce plan fournit aussi de ce fait un cadre propre à faciliter et à encourager de légères mais fréquentes modifications de parité.
Le pair des monnaies des pays membres continuerait à être exprimé en or ou en droits de tirage spéciaux (DTS). Les marges de change seraient élargies et portées de 1 pour cent – écart autorisé par les Statuts – à, peut-être, 3 pour cent. Pour chaque pays visé par la proposition, on établirait une “zone d’équilibre des parités”. A l’intérieur de cette zone, les parités réuniraient automatiquement les conditions requises pour être autorisées par le Fonds, et les modifications de parité pourraient être décidées par le membre qui en aviserait le Fonds. Cette zone serait conçue de façon à couvrir l’écart à l’intérieur duquel une parité établie par le membre pourrait raisonnablement être jugée compatible avec l’équilibre de sa balance des paiements. A titre d’illustration, on suppose que cette zone aurait un écart standard de 10 points de pourcentage (autrement dit, 5 pour cent de part et d’autre du point central).
Ladite zone serait établie à des intervalles périodiques au moyen d’un processus de consultation internationale. De façon générale, les membres devraient veiller à ce que leurs parités ne s’écartent pas de la zone d’équilibre, soit en leur apportant des modifications appropriées, soit en prenant, en dehors de la sphère des taux de change, des mesures (par exemple par le jeu de la politique monétaire ou financière) qui exerceraient sur la balance des paiements une influence suffisante pour déplacer la zone d’équilibre des parités de manière à ce qu’elle couvre la parité du membre. Chaque fois que la parité d’un membre s’écarterait de sa zone d’équilibre, elle cesserait de bénéficier automatiquement de l’approbation du Fonds. Le membre aurait alors une parité qui ne serait pas autorisée par le Fonds et il ne pourrait pas avoir accès aux ressources du Fonds. Ceci découragerait les pays déficitaires mais n’aurait habituellement guère d’influence sur les pays dont la situation des paiements est forte. Il serait donc souhaitable d’instituer une sanction équivalente pour agir sur les pays excédentaires. A cet égard, on pourrait envisager de ne pas leur attribuer d’allocations de droits de tirage et peut-être aussi de limiter les paiements d’intérêt sur ces droits de tirage. De toute façon, on pourrait attribuer au Fonds une certaine latitude pour décider soit d’autoriser, soit d’entériner d’une autre manière, dans des cas exceptionnels, une parité se situant en dehors de la zone d’équilibre.
El régimen de tipos de cambio : Análisis y proyecto de sistema
Resumen
Un aspecto central de los futuros sistemas monetarios es la función del ajuste de los tipos de cambio. En este trabajo se examinan los objetivos del régimen de tipos de cambio, algunas de sus consecuencias en las principales características del mecanismo de los tipos de cambio y un proyecto de un nuevo sistema que podría dar al marco del sistema de paridades el grado de flexibilidad necesario.
La experiencia de los últimos años indica que al recurrir activamente al ajuste de las paridades los principales países, con un régimen de márgenes estrechos, se plantean los problemas siguientes: a) la estabilidad a corto plazo de los tipos de cambio puede ser incompatible con la estabilidad a plazo más largo, b) es probable que los movimientos desestabilizadores de capital a corto plazo sean importantes y tengan efectos acumulativos al repetirse el ajuste de las paridades, y c) la aplicación de los ajustes de las paridades puede requerir prolongadas negociaciones entre los principales países, en cuanto a la modificación o no modificación de sus respectivas paridades, lo que supondría la formulación de un criterio internacional acerca del nivel adecuado de las paridades nacionales, es decir, ir más allá de lo que dispone el Convenio Constitutivo del Fondo para la validación internacional de las propuestas de modificación de las paridades presentadas por iniciativa de los países miembros. Sin una reforma institucional, el sistema de paridades no es por sí mismo un sistema estable, en circunstancias en que no puedan lograrse tipos de cambio fijos, o sólo a un costo en función de los objetivos básicos.
Estos problemas han motivado una gran variedad de propuestas para modificar el actual sistema, incluidas las que corresponden a la categoría general de las paridades móviles. El propósito común de estas propuestas ha sido facilitar el más flexible ajuste de los tipos de cambio, evitando ciertas dificultades propias del actual sistema de ajuste cambiario, y manteniendo al propio tiempo salvaguardias contra fluctuaciones excesivas.
El sistema que a título de ejemplo se describe en este trabajo constituye una variante del sistema de paridades flexibles. Lo fundamental del sistema es dejar amplio campo a discreción de los países para fijar las paridades y perfeccionar los procedimientos internacionales utilizados para modificar las paridades dentro de dicho campo, si bien creando presiones internacionales más fuertes e institucionalizadas contra una manifiesta inadecuación de los tipos de cambio, suponga o no la modificación de la paridad de un determinado país. Así, el sistema también proporciona un marco que facilitaría y fomentaría modificaciones pequeñas y frecuentes de las paridades.
Los países miembros continuarían expresando las paridades de sus monedas en oro o derechos especiales de giro (DEG). Los márgenes de fluctuación se ampliarían del 1 por ciento, que autoriza el Convenio Constitutivo a, quizá, el 3 por ciento. Se establecería una “zona de equilibrio de la paridad” para la moneda de cada país incluido en la propuesta. Dentro de dicha zona, las paridades serían automáticamente autorizadas por el Fondo, y se podrían modificar por decisión del país miembro notificando al Fondo. La zona se establecería de modo que abarcara el campo en que una paridad fijada por un país miembro pudiera considerarse razonablemente coherente con el equilibrio de su balanza de pagos. A título de ejemplo, se supone que la zona tendría una amplitud normal de 10 puntos porcentuales (es decir, 5 por ciento a ambos lados del punto central).
La zona se determinaría a intervalos periódicos por consulta internacional. En general, los países miembros deberían evitar que la paridad de sus monedas cayera fuera de la zona de equilibrio, ya fuera mediante las oportunas medidas con respecto a sus paridades, o recurriendo a medidas de carácter no cambiario (por ejemplo, de política monetaria o fiscal) que influyeran lo bastante en la evolución de la balanza de pagos de forma que la zona de equilibrio de la paridad se desplazase a una posición en que quedara comprendida la paridad del caso. Siempre que la paridad de un país se encontrara fuera de su zona de equilibrio, dejaría de recibir la aprobación automática del Fondo. El país tendría entonces una paridad no autorizada por el Fondo, y quedaría inhabilitado para utilizar los recursos del Fondo. Esto sería un factor disuasivo para los países deficitarios, pero normalmente tendría poca influencia en los países con posición de pagos fuerte. Por tanto, sería conveniente adoptar sanciones semejantes frente a los países con superávit. En este sentido, podría estudiarse la suspensión de asignaciones de DEG y también, posiblemente, la limitación del pago de los intereses devengados por los DEG. No obstante, en casos excepcionales el Fondo tendría cierta libertad para autorizar una paridad fuera de la zona de equilibrio, o acceder a ella de algún otro modo.
Mr. Hirsch, who was Senior Advisor in the Fund’s Research Department when this paper was prepared, has now taken up a Research Fellowship at Nuffield College, Oxford.
The parentheses refer in each case to the enumeration of underlying objectives listed earlier.
Article IV, Section 5(a).
Article I, cited above.
International Monetary Fund, The Role of Exchange Rates in the Adjustment of International Payments: A Report by the Executive Directors (Washington, 1970), pp. 47–48 (hereinafter referred to as The Role of Exchange Rates).
The concept of the effective exchange rate was discussed in Fred Hirsch and Use Higgins, “An Indicator of Effective Exchange Rates,” Staff Papers, Vol. XVII (1970), pp. 453–87.
Thus, Italy and Sweden in December 1971 devalued by 1 per cent in terms of gold, revalued by 7½ per cent vis-à-vis the U.S. dollar, and devalued by varying amounts ranging to 9½ per cent against currencies of other industrial countries.
A more extended analytical survey of such proposals has been made by Michael Kuczynski in “Proposals for Small and Perhaps Frequent Changes in Par Values” (unpublished, International Monetary Fund, February 3, 1969).
As indicated in the reference to the concept of fundamental disequilibrium in The Role of Exchange Rates (cited in footnote 3).
Strictly, par value zone, related to the par value in terms of the numeraire. For ease of expression, the concept of parities is used in the sense of par values.
Actually by 3.1 points, as the tolerated limit is now measured from 102. For simplicity, the examples that follow base the calculations on 100.
