Flexible As Exchange Rates example essay topic

The first papers deals with: Exchange rates and the choice of monetary policy regimes -Fewer monies better monies, by Rudi Dorn busch. A century ago gold was the standard for civilization. Gradually this had become international and countries if they were not on gold, at least they were on sterling or the dollar. After world war one all that fell apart in the great depression with capital controls, devaluation and discretionary central banking.

Exchange rates and the choice of monetary policies. After the great inflation of the 1970's, extreme monetary experiences in most developing nations, the past 20 years have changed monetary management fundamentally. Emerging economic trend is for independent central banks with transparency and some inflation target. Emerging trend is also towards monetary integration.

In Europe they have got the EMU. In Americas progress on monetary integration is far more haphazard. Europe and Americas independence makes political integration an uninteresting issue. A national currency as opposed to a hard dollar peg, is seen as an unquestioned plus for reasons to be discovered. In Asia the discussion of monetary arrangements is picking up at the (1) behest of Japan. (Eiji Ogawa and Taka toshi Ito, 2000).

Arguments against currency board arrangements 1. Sovereignty is beyond discussion because of the quality of money and the emerging economies. 2. As far as loss of seigniorage is a critical issue for public finance but any kind of stability-oriented monetary policy will yield some bonus but currency boards and dollar ization presumably commands the highest bonus. 3. As far as the monetary policy is concerned, the external balance not the local central bank will determine interest rates so this issue has very little importance.

4. There is a concern about loss of the leader of last resort. 5. Another argument in questioning currency boards is fiscal preparedness. How a discretionary monetary and exchange rate policy can accomodate a bad fiscal situation better than a fixed rate. The savings on debt service from lower interest rate under a currency board should compensate for the loss of seignorage.

Exchange rate issue Author argues that disturbance in price levels due to fixed exchange rate could be tackled by financing. For relative price adjustments partial adjustment of consumption or (2) investment and current account financing should be most of the buffer. There should be a flexibility of wages and prices. Author argues that if anything exchange rates have been the dominant instrument of destabilization. Author favours the monetary policy regimes and fixed exchange rates says that gains come in two forms: 1. There is a dramatic decline in interest rates with all attendant benefits (Francesco Giavazzi and Marc Pagano 1988).

In case of Greece and Italy becoming part of EMU the gains were striking and some for Argentina. 2. Transformation of the financial sector and the lengthening of agents horizons. With low inflation and stable inflation and a stable currency, economic horizons lengthen, which is conducive to investment and risk taking which translates in to growth. Once the economy stabilizes distortions and inefficiencies become far more apparent and can be tar gates.

Hence a monetary regime that delivers and maintains low inflation other things equal will help growth. Author argues that much talked about case of Argentina as an example of failure of currency board. The reasons were: 1. Argentina has a very high level of debt and very poor fiscal situation. 2.

Argentina has invested little, economy obsolete, closed. (3) 3. Legacy of labour relations, unions. Author says that Mexico is a good candidate for currency board most trade is with U. S, NAFTA. 2. Second article is on "A Reconsideration of the twentieth century by R. A Mundell.

Author discusses role of the monetary factor as a determinant of political events. He argues that many of the political changes inthe century (which he calls as American Century) have been caused by little understood perturb ances in the international monetary system, while there in turn have been a consequence of the rise of the U. S and mistake of its financial arm the Federal Reserve system. The Author argues that the flexible exchange rates did not provide the same discipline as the fixed rates. The cost of inflation are much higher in a world with progressive income tax rates. And a need for and means of attaining monetary stability can be learned.

It is also said that the policy mix can shift the Phillip curve. Author state that experience breeds its own reaction as Plato the inflationist gave birth to Aristotle, the hard money man. The reaction in the 1980's gave a boost to central bank independence. Governments had to cut back on spending growth as well as deficits.

Authors establish that flexible exchange rates are an unnecessary evil (4) in a world where each country has achieved price stability. The main points come out of this article are: ! International monetary system depends on the power configuration of the countries that make it up.! Despite the incredible rise in gold production, Gresham's law came in to play and the dollar elbowed out gold as the principal international money.! In the first third of the twentieth century there was a confrontation of the Federal Reserve System and standard of gold.! The gold standard was broken down in World War 1 restored in 1920's and created deflation in 1930's.

The great depression led to totalitarianism and World War 2.! Second third of the twentieth century was dominated by the contradiction between national macroeconomics and its management and new international monetary system. U. S fixed the price of gold and different countries fixed their currencies to the convertible dollar 1970's U. S stopped fixing price of gold and other countries stopped fixing the price of dollar.! 1990 started with the search of new international monetary architecture. (5) Today they talk about stability, fiscal prudence and inflation control.! The dollar, the euro and the yen have established.! Things to be corrected are exchange rate volatility and the absence of international currency.

For inflation and unemployment to control, cuts in marginal tax rates were needed, tight money would produce price stability. The third article is on The care for flexible exchange rates. Author argues that in current economic and political conditions flexible exchange rates suit more. He says that 1. these conditions make a system of flexible or floating exchange rate which are freely determined in an open market primarily by private dealings and like other market prices varying from day to day. 2. The achievement and maintenance of a free and prosperous world community with unrestricted multilateral trade.

3. There is no facet of international economic policy for which the acceptance of a system of rigid exchange rates does not create serious problems. 4. Promotion of rearmament, liberalization of trade, avoidance of allocations and other direct control, harmonization of internal monetary and fiscal policies there problems become easier to solve in a world of (6) flexible exchange rates and its corollary free convertibility of currencies. 5. Unrestricted multilateral trade will become a real possibility with flexible exchange rates.

According to the author instability of exchange rates ia a symptom of instability in the economic structure. Unrestricted multilateral trade means no direct quantitative controls over imports and exports. Author suggests alternative methods of adjusting to changes affecting international payments. 1. Countray's currency may bid up or put up in price. This will make currency less desirable relative to the currency of other countries and thus eliminate the excess demand at preexisting rate.

2. Prices within country may rise and thus goods demand within the country less desirable relative to goods in other countries. 3. Direct control over transactions.

4. Excess amount of domestic currency may be provided out of monetary reserves. He further argues that changes in the exchange rates may be used to maintain equilibrium in the balance of payments through 1. flexible exchange rates. 2. official changes in rigid rates. (7) If Germany had a flexible exchange rate in 1950 it would have not created such a crisis as Germany faced. He further gives the example of U.K. He concludes that changes in temporarily rigid exchange rates neither provide stability nor the continuous sensitivity of a flexible exchange rate. While discussing internal prices or income author says that if the internal prices are as flexible as exchange rates then it would make little economic differences.

Wage rates tend to be among the less flexible prices. Direct control on imports, exports and capital movements could bring about the same effect on trade and the balance as changes in exchange rates. However the direct controls have a tendency to make the incentive to export lower than it would otherwise be. Monetary reserves must be used for to retire debt or to finance a deficit in the budget to prevent price decline. He states that flexible exchange rate is the best device suitable for current conditions as use of reserve is not a feasible device, direct control are inefficient, changes in internal prices and income are undesirable.

There are three naj or objectives to flexible exchange rates: 1. flexible rates increase the degree of uncertainty. (8) 2. make it impossible for exporters and importers to be certain about the price they will have to pay or receive in foreign exchange. 3. speculation in foreign exchange markets tend to be destabilizing. He argues that there is nothing essential in EMU that would be an obstacle to flexible exchange rates. Same comments apply to international monetary funds.

A fixed price for gold can be maintained in one country without interfering with flexible exchange rates. U. S now has such fixed price. Gold is a highly safe means of keeping liquid reserve so there should be a free gold market. As far as sterling area is concerned, flexible exchange rates could be instituted within the sterling area and sterling and other currencies or fixed exchange rates could be retained within the sterling area. Flexible exchange rates would help in 1. Unrestricted multilateral trade. 2.

The harmonization of internal monetary and fiscal policies. 3. The rearmament drive. Countries separately or jointly establish a system of exchange rates freely determined in open market by private transactions, abandonment of direct controls over echange transactions. This move is a basic requirement for the economic integration of the free world through (9) multilateral trade. Emerging trend is towards monetary integration.

EMU has given enough impact on to this. NAFTA is also forwarding towards the integration. In asia the discussion of monetary arrangements is picking up. Fixed exchange rate provide decline in interest rates, inflation, stability, trade and economic uplift ment.

The dollar, the euro and the yen have established as three monetary stability islands. Efforts are moving towards an international currency and fixed exchange rates.