Chapter 25
National and Global Choices: Floating Rates and the Alternatives This chapter provides a capstone to the discussion of international finance and international macroeconomics by examining the choice between fixed and floating exchange rates. Much of the discussion examines this choice from the point of view of a single country, but the discussion also examines some issues related to the functioning of the entire system.
Knowledge Points
The text examines five key issues that can influence a country's choice. Figure 25.1 presents a summary of implications of the key issues for the advantages of each policy choice.
National and Global Choices: Floating Rates and the Alternatives
If the only relevant national goal is to defend the fixed rate, then the currency board is probably better. Because the currency board holds no domestic-currency assets, the currency board cannot sterilize its foreign exchange intervention. The domestic money supply must change with the intervention, and the adjustments to eliminate the payments imbalance takes place.
The members of the European Union (EU) are pursuing an international fix—a monetary union in which exchange rates are permanently fixed among the currencies of the countries in the union and a single monetary authority conducts a unionwide monetary policy. As mentioned previously in Chapter 20, in 1979 the EU countries established the European Monetary System, and most became members of its Exchange Rate Mechanism (ERM), an adjustable pegged rate system among its members' currencies.
Key gains from European Monetary Union are the elimination of exchange rate risk and the elimination of the transaction costs of exchanging currencies. Key risks include the loss of national use of exchange rate changes and monetary policy to address shortcomings in national economic performance. The ECB’s monetary policy can address union-wide macroeconomic performance shortcomings, as it did starting in 2015 when the ECB began an aggressive quantitative easing to address very low euro area inflation rates, slow real GDP growth, and high unemployment rates.
Each country must make its own decision about its exchange rate policy. Several of these key issues seem to be important for most countries. Strong arguments in favor of a country's choosing a floating exchange rate are the use of changes in the floating exchange rate to achieve external balance, so that monetary policy can be used to pursue domestic objectives, the ability to set its own goals and policies, and the reduced need to hold official international reserves to defend against speculative attacks on the fixed rate.
Third, countries that have their currencies linked through fixed exchange rates must achieve consistency in their macroeconomic policies, so that the fixed rate can be defended and maintained. If countries have different goals, priorities, and policies, then they will favor floating exchange rates.
Cases
The members of the European Union (EU) are pursuing an international fix—a monetary union in which exchange rates are permanently fixed among the currencies of the countries in the union and a single monetary authority conducts a unionwide monetary policy. As mentioned previously in Chapter 20, in 1979 the EU countries established the European Monetary System, and most became members of its Exchange Rate Mechanism (ERM), an adjustable pegged rate system among its members' currencies.
The members of the European Union (EU) are pursuing an international fix—a monetary union in which exchange rates are permanently fixed among the currencies of the countries in the union and a single monetary authority conducts a unionwide monetary policy. As mentioned previously in Chapter 20, in 1979 the EU countries established the European Monetary System, and most became members of its Exchange Rate Mechanism (ERM), an adjustable pegged rate system among its members' currencies. By mid-1992 all EU members except Greece were members of the ERM. Then a series of speculative attacks weakened the ERM—Britain and Italy left it in 1992, realignments were necessary for the central rates of the currencies of some other countries, and the bands for nearly all currencies were widened to plus or minus 15 percent in 1993. After 1993 the exchange rates within the ERM were generally steady, and a
Fiscal policy has become a flash point for the euro area. In the absence of national monetary policy and national exchange rate policy, national fiscal policy should be valuable as the key tool for national macroeconomic stabilization. But national governments may sometimes run excessive fiscal deficits and build up excessive government debt.
Fiscal policy has become a flash point for the euro area. In the absence of national monetary policy and national exchange rate policy, national fiscal policy should be valuable as the key tool for national macroeconomic stabilization. But national governments may sometimes run excessive fiscal deficits and build up excessive government debt. The Stability and Growth Pact attempted to impose limits on the size of national government budget deficits, but the pact was weakened in 2005. Then the global financial and economic crisis led to ballooning deficits in some euro-area countries. Greece had to be rescued from a government debt crisis in 2010, followed by Ireland and Portugal. In mid-2011 the government debts of Spain and Italy came under market pressures. National fiscal policies and national government debt were central to the crisis that threatened the viability of the euro. The eu
Key gains from European Monetary Union are the elimination of exchange rate risk and the elimination of the transaction costs of exchanging currencies. Key risks include the loss of national use of exchange rate changes and monetary policy to address shortcomings in national economic performance. The ECB’s monetary policy can address union-wide macroeconomic performance shortcomings, as it did starting in 2015 when the ECB began an aggressive quantitative easing to address very low euro area inflation rates, slow real GDP growth, and high unemployment rates.
Key gains from European Monetary Union are the elimination of exchange rate risk and the elimination of the transaction costs of exchanging currencies. Key risks include the loss of national use of exchange rate changes and monetary policy to address shortcomings in national economic performance. The ECB’s monetary policy can address union-wide macroeconomic performance shortcomings, as it did starting in 2015 when the ECB began an aggressive quantitative easing to address very low euro area inflation rates, slow real GDP growth, and high unemployment rates. But, a major challenge for the member countries is finding effective mechanisms for national adjustments when adverse economic shocks affect different countries in different ways (for instance, Germany and Ireland during the early 2000s). Labor mobility between member countries is low. “Internal devaluation” to improve international
Given the importance of having and maintaining similar inflation rates for the success of fixed exchange rates, the most important criterion is probably that related to the country's inflation rate. The criteria related to government budget deficits and debt seem to be more debatable. A country that shifts to completely fixed exchange rates has given up the ability to use national monetary policy and exchange rate changes in seeking to address imbalances.
Given the importance of having and maintaining similar inflation rates for the success of fixed exchange rates, the most important criterion is probably that related to the country's inflation rate. The criteria related to government budget deficits and debt seem to be more debatable. A country that shifts to completely fixed exchange rates has given up the ability to use national monetary policy and exchange rate changes in seeking to address imbalances. This country may need to use fiscal policy more actively, including sometimes running large budget deficits. If the criteria also restrain the independence of fiscal policy, the country's government is left with little in the way of policy tools to address national imbalance. However, the series of government debt crises that hit Greece, Ireland, and Portugal beginning in 2010 show that excessive fiscal deficits and government debts can
Exercises
Which of the following is most likely to happen if the demand for money decreases in the domestic economy under floating exchange rates and free capital mobility?
正确答案：C | The financial account of the country's balance of payments will deteriorate.
难度：2 Medium Bloom's：Understand
Monetary policy is most effective in influencing aggregate demand
正确答案：A | under a freely floating exchange-rate system.
难度：1 Easy Bloom's：Remember
Fiscal policy is most effective in influencing aggregate demand
正确答案：A | under a floating exchange-rate system with a low degree of capital mobility.
难度：1 Easy Bloom's：Remember
Those who advocate a return to a real gold standard believe that doing so would
正确答案：D | reduce inflation rates by imposing strong discipline on national monetary authorities.
难度：1 Easy Bloom's：Remember
Under a gold standard, a major discovery of a new gold deposit would
正确答案：B | increase the inflation rate.
难度：1 Easy Bloom's：Remember
A domestic monetary shock is least disruptive
正确答案：C | under a fixed exchange-rate system without sterilization.
难度：2 Medium Bloom's：Understand
The process of "demonetization of gold" involves
正确答案：C | gold sales into the private market in recent decades by central banks and the International Monetary Fund (IMF).
难度：1 Easy Bloom's：Remember
A domestic spending shock is likely to be least disruptive under a
正确答案：A | floating exchange-rate system when there is high capital mobility.
难度：2 Medium Bloom's：Understand
For an international capital-flow shock in which foreign investors lose confidence in a country
正确答案：D | the country's real GDP tends to decline if the country has a fixed exchange rate, but the country's real GDP tends to increase if the country has a floating exchange rate.
难度：2 Medium Bloom's：Understand
Export demand shocks are likely to be least disruptive to a country with
正确答案：A | a floating exchange-rate system.
难度：2 Medium Bloom's：Understand
An international trade shock arising from a sudden increase in import demand is likely to be least disruptive to a country with
正确答案：A | a floating exchange-rate system.
难度：2 Medium Bloom's：Understand
Which of the following statements is true?
正确答案：C | With floating exchange rates, the transmission of business cycles through foreign trade and repercussion is less than with fixed exchange rates.
难度：2 Medium Bloom's：Understand
Manual Preview
National and Global Choices: Floating Rates and the Alternatives
This chapter provides a capstone to the discussion of international finance and international macroeconomics by examining the choice between fixed and floating exchange rates. Much of the discussion examines this choice from the point of view of a single country, but the discussion also examines some issues related to the functioning of the entire system.
The text examines five key issues that can influence a country's choice. Figure 25.1 presents a summary of implications of the key issues for the advantages of each policy choice.
First, different types of shocks have different effects, depending on which exchange rate policy is chosen. Internal shocks, especially domestic monetary shocks, are less disruptive to the domestic economy with a fixed exchange rate. External shocks, especially international trade shocks, are less disruptive with a floating exchange rate. If a country believes that it is mainly hit with internal shocks, it would favor a fixed rate; if it believes that it is mainly hit by external shocks, it would favor a floating rate.
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