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Money Markets and Politics

A Study of European Financial Integration and Monetary Policy Options

Jens Forssbæck and Lars Oxelheim

The dramatic evolution of financial markets in the 1980s and 1990s, accompanied by increasing institutional integration between nations (most notably in the EU), have fostered a widespread belief that governments – particularly those of small economies – have essentially lost the power to pursue sovereign, independent economic policies. At the same time, it is widely assumed that the loss of monetary-policy control is a major opportunity cost for a country adopting a rigid exchange-rate regime or, in the European context, for countries joining the EMU This book sheds light on these arguments.
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Chapter 5: External Arrangements: Exchange Rate Regimes and Capital Controls

Jens Forssbæck and Lars Oxelheim


The aims of this chapter are, first, to provide a general overview of exchange rate arrangements in the survey countries during the period 1979–2000; second, to classify the actual exchange rate regimes pursued during different periods in a few simple categories that will allow us to study the degree of financial integration and monetary autonomy in shifting institutional settings. It follows from the general conceptual framework described in Chapter 1 that the relationship between capital mobility and monetary autonomy is assumed to depend critically on the exchange rate regime. What we are looking for is a classification scheme that captures the main choice between fix and float, but also leaves room for some nuance – specifically, since many of the countries have been involved in the exchange rate cooperation within the European Monetary System (EMS), this should be reflected in the classification. Moreover, it is appropriate to let the imposition of administrative restrictions on capital account transactions (that is, capital controls) be an aspect of the formal institutional arrangements of exchange rate management (though conceptually, it might be more related to the idea of capital mobility). Based on these considerations, a framework for the classification of exchange rate regimes is depicted in the matrix in Figure 5.1. The matrix categorizes exchange rate arrangements according to two dimensions: what is the principal regime pursued for the exchange rate, and are restrictions on capital movements imposed to support the regime? The categorization of exchange regimes in the matrix is a simplification of...

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