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How well are fluctuating exchange rates working?

May 22, 2010

Focusing on the questions (a) of how well fluctuating exchange rates are working and on the related issue (b) of what sort of guidelines should be established to regulate central bank intervention in exchange markets is particularly appropriate now for a number of reasons.

First, despite the float, the dollar continues to slip in exchange markets even after the President’s announcement last Wednesday of his new anti-inflationary measures. One wonders whether these current disturbances are in fact less disruptive under fluctuating rates than they would have been under previous fixed-rate arrangements.

Second, the point has been made that perhaps floating rates will be with us, if not forever, at least for a good long time. Otmar Emminger, deputy governor of the West German Bundesbank, recently suggested that the world might have to live with floating rates indefinitely in order to keep international capital flows in check. He said:

“It is difficult to see how we can dispense with a more elastic exchange rate system.”

A third reason why it is appropriate to focus on these two questions today is that as long as inflation continues at present rates in the major industrial countries, and especially in the United States, fluctuating exchange rates are likely to be a necessity to counteract price increases.

And a fourth reason why it is well to focus on the two questions has to do with the guidelines “themselves. The Bank of England recently acknowledged that it had been intervening in exchange markets. And Italian authorities have announced their intention of doing the same thing. These interventions pose the question of to what extent central bank intervention is a desirable means of either dampening exchange rate fluctuations or working gradually toward a return to more rigid rates.

The issue we address in these hearings is whether the floating rate regime, while not necessarily ideal, is the best feasible compromise under today’s conditions. We will hear from economists and U.S. officials next week. Today and tomorrow we turn to those who contend day to day with the practical problems raised by fluctuating exchange rates.

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