Extract

Andrew Crockett The choice of exchange rate regime is a subject that attracts strong opinions, often based on weak theory. At various times during the twentieth century, there has been an academic or policy consensus for pretty much the full range of possible regimes: fixed rates (the gold standard); floating rates; neither fixed nor floating rates (the Bretton Woods adjustable peg); agnosticism (‘anything goes’); and either fixed or floating rates (the ‘bipolar view’). This last, based on the presumed instability of intermediate exchange rate systems, seems close to becoming the new conventional wisdom. Given this shifting policy perception, it seems worthwhile to reexamine the issue. Has the evolution of thinking been the result of increased wisdom – a better understanding of the basic model? Does it reflect shifts in economic structures and responses – changing model structures? Or is it a matter of different preferences for economic outcomes – shifts in policy-makers’ objective functions? To some extent, all three factors have played a role. Theoretical and empirical insights have brought increased awareness of the characteristics of different regimes. Concepts such as the ‘impossible trinity’, optimum currency areas, exchange rate overshooting, and multiple equilibria, together with real-life experience of currency and banking crises have sharpened our awareness of the physiology of exchange rate regimes and their pathology under stress. Changes in economic structures may have also been a factor in how exchange regimes work. From a theoretical standpoint, the case for one regime against another depends on some imperfection in the...