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Exchange Rate Regimes in the Modern Era

Exchange Rate Regimes in the Modern Era

Michael W. Klein
Jay C. Shambaugh
Copyright Date: 2010
Published by: MIT Press
Pages: 266
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  • Book Info
    Exchange Rate Regimes in the Modern Era
    Book Description:

    The exchange rate is sometimes called the most important price in a highly globalized world. A country's choice of its exchange rate regime, between government-managed fixed rates and market-determined floating rates has significant implications for monetary policy, trade, and macroeconomic outcomes, and is the subject of both academic and policy debate. In this book, two leading economists examine the operation and consequences of exchange rate regimes in an era of increasing international interdependence.Michael Klein and Jay Shambaugh focus on the evolution of exchange rate regimes in the modern era, the period since 1973, which followed the Bretton Woods era of 1945--72 and the pre-World War I gold standard era. Klein and Shambaugh offer a comprehensive, integrated treatment of the characteristics of exchange rate regimes and their effects. The book draws on and synthesizes data from the recent wave of empirical research on this topic, and includes new findings that challenge preconceived notions.

    eISBN: 978-0-262-25900-2
    Subjects: Business, Economics

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. Acknowledgments
    (pp. ix-xii)
    MWK and JCS
  4. I Introduction

    • 1 Exchange Rate Regimes in the Modern Era
      (pp. 3-10)

      The dollar–euro exchange rate, perhaps ʺthe worldʹs single most important price,ʺ is determined by market forces, and changes day to day, and even minute to minute. In contrast, each of the countries of the European Union that uses the euro as its national currency experiences no exchange rate changes with the other members of the eurozone because they share a common currency. Why is it that the United States allows its currency to float, while Germany, France, and the other members of the eurozone have abandoned their national currencies and, effectively, have set a fixed exchange rate across Europe?...

  5. II The Nature of Exchange Rate Regimes

    • 2 Exchange Rate Regimes in Theory and Practice
      (pp. 13-28)

      More than a full century separates John Stuart Millʹs writing of the ʺbarbarismʺ of countries desiring their own currencies, and Milton Friedmanʹs argument that flexible exchange rates are ʺabsolutely essentialʺ for economic prosperity. If economics progressed like the natural sciences, one might be able to say that Friedmanʹs mid-twentieth-century perspective favoring flexible exchange rates reflected an advance in knowledge over Millʹs mid-nineteenth-century view of the desirability of fixed exchange rates backed by precious metals, just as physicistsʹ understanding of electromagnetism today is more subtle than that developed by Michael Faraday, Millʹs contemporary. One could even hope that today, at the...

    • 3 Exchange Rate Regime Classifications
      (pp. 29-50)

      Exchange rates are precisely measured. Exchange rate regimes are not. The first challenge facing those who want to understand the characteristics and consequences of exchange rate regimes is the identification and implementation of a classification scheme. This scheme must define the categories that constitute an exchange rate regime and provide a set of criteria that classifies a countryʹs experience in a particular time period into one of those categories. These are far from trivial tasks, and as Frankel has noted, ʺplacing actual countries into those categories is more difficult than one who has never tried it would guess.ʺ¹

      Exchange rate...

    • 4 The Dynamics of Exchange Rate Regimes
      (pp. 51-72)

      The economic consequences of the choice of an exchange rate regime, as outlined in chapter 2, represent one of the classic lines of inquiry in international finance. As discussed in chapter 3, with the advent of the modern era, a wide set of experiences with exchange rate regimes emerged. These experiences over a four-decade time period offer a rich tableau for investigating the effects of exchange rate regimes on trade, growth, stability, and other economic outcomes. But these inquiries are partially predicated on the durability of countriesʹ exchange rate regimes.¹ For example, it is difficult to imagine fixed exchange rates...

    • 5 The Empirics of Exchange Rate Regime Choice
      (pp. 73-98)

      Governments make a wide range of decisions on economic policy. Some of these decisions represent a set of institutional choices that are made infrequently, such as the development or modification of statutes governing the operation of a central bank. Other choices are made more often, as a response to immediate concerns; for example, the passage of a short-run fiscal stimulus package to counter an economic downturn. In both cases it is also important to recognize that decisions are typically not made by the ʺbenevolent social plannerʺ of economic theory, rather economic choices often reflect political struggles among several competing interest...

  6. III Exchange Rate Consequences of Exchange Rate Regimes

    • 6 Exchange Rate Regimes and Bilateral Exchange Rates
      (pp. 101-116)

      Saying doesnʹt make it so. Or, in the case of exchange rate regimes, a government that declares that it has a floating exchange rate might not in fact allow its currency to freely fluctuate. For the exchange rate regime to matter to economic outcomes, it seems a prerequisite that the regime makes a difference in the behavior of the exchange rate. These next two chapters will consider what we might call the exchange rate effect of fixed exchange rates.

      The mere classification of annual observations into those categorized as pegs and those categorized as floats (or, more accurately, nonpegs) would...

    • 7 Exchange Rate Regimes and Multilateral Exchange Rates
      (pp. 117-130)

      An exchange rate is inherently bilateral. That is, one cannot speak precisely about the dollar depreciating or appreciating without specifying the currency against which it moves. The dollar could be rising against one currency and falling against another at the same time. This seemingly simple observation is a crucial one for the economics of exchange rate regimes in the modern era. It also distinguishes the modern era from the gold standard or Bretton Woods periods when the use of a common anchor by nearly all countries meant that pegs in those eras would almost automatically be stabilizing the multilateral as...

  7. IV Economic Consequences of Exchange Rate Regimes

    • 8 Exchange Rate Regimes and Monetary Autonomy
      (pp. 133-146)

      Chapter 2 introduced the concept of the trilemma. A country cannot pursue more than two of the three options of a fixed exchange rate, open financial markets, and domestic monetary autonomy. This core concept of international macroeconomics is very general, and it is an implication of a wide range of macroeconomic models that allow for international trade in assets, but it also follows from fairly basic intuition.

      The trilemma is sometimes summarized to mean that countries can operate with an open capital market, a peg and zero autonomy; a closed capital market, a peg with autonomy; or an open capital...

    • 9 Exchange Rate Regimes and International Trade
      (pp. 147-164)

      Slogans are meant to rally opinion, not to reflect subtleties. Thus the slogan ʺOne market, one moneyʺ was an effective, if not totally convincing, call by the European Commission for a single currency in Europe in order to solidify the continentʹs trade integration.³ At the time the 1989 Delors Report was prepared by the European Commission (headed by its president, Jacques Delors), there was actually little systematic empirical evidence that a single currency would promote international trade.

      The empirical regularity that the slogan did reflect was the longstanding view of the importance of exchange rate stability in Europe. The memory...

    • 10 Exchange Rate Regimes and Inflation
      (pp. 165-184)

      Exchange rate regimes are monetary constructs. This is evident from the policy trilemma, since monetary policy becomes subject to exchange rate management when a country has open capital markets. Thus the famous dictum of Friedman and Schwartz that serves as the epigraph of this chapter suggests that inflation would likely differ systematically between countries that peg and countries that do not peg during the modern era.

      The stark assertion by Friedman and Schwartz, of a monocausal source of inflation, has another implication for the role of the pegged exchange rates in determining inflation; there should be no effect of a...

    • 11 Exchange Rate Regimes and Economic Growth
      (pp. 185-202)

      Long-run monetary neutrality is one of the oldest, and most widely accepted, propositions in macroeconomics. One implication of this proposition is that the long-run real value of an economyʹs output cannot be altered simply by printing money. More broadly, long-run monetary neutrality implies that no nominal variable has an effect on real outcomes over an extended period of time (though there is debate on the time frame over which this proposition holds).¹

      A corollary of long-run monetary neutrality, one of interest for the topic of this book, is of the long-run neutrality of the choice of the exchange rate regime....

  8. V Conclusion

    • 12 Exchange Rate Regimes in an Interdependent World
      (pp. 205-208)

      Perhaps no single price attracts as much attention as the exchange rate, the price of one currency in terms of another. Certainly no other price has an entire branch of economics dedicated to its study. In some ways the exchange rate is simply an asset price like any other, responding to fundamentals and expectations. At the same time it serves as the translator of the value of goods, services, and assets in one country compared to another. Consequently no other price has as much government intervention as the exchange rate and the decision of how to treat it—whether to...

  9. Notes
    (pp. 209-228)
  10. References
    (pp. 229-240)
  11. Index
    (pp. 241-254)