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Exchange Rate Choices

Richard N. Cooper

Harvard Institute of Economic Research Working Papers from Harvard - Institute of Economic Research

Abstract: By late 1998, 101 countries had declared that their currencies were allowed to float against other currencies, meaning that the currency was not formally pegged to some other currency or basket of currencies. This was up from 38 ten years earlier, suggesting a significant move toward greater flexibility of exchange rates. Yet during the 1990s half a dozen countries installed currency boards, a particular strong form of exchange rate fixity; ten European currencies were eliminated in favor of a common currency, the euro; other countries were actively considering installing currency boards, or even adopting the US dollar for domestic use.

After a quarter century of floating among the major currencies, exchange rate policy is sstill a source of vexation, and the appropriate choise is by no means clear. Should a country allows its currency to float, subject perhaps to exchange market intervention from time to time? Or should it fix its currency to some other currency or currencies, and if so to which one(s)? Economists do not offer clear persuasive answers to these questions. Yet for most countries, all but the largest, with the most develoed domestic capital markets, the choise of excahnge rate policy is probably their single most important macro-economic policy decision, strongly influencing their freedom of action and effectiveness of other macro-economic policies, the evolution of their financial systems, and even the evolution of their economies.

This paper will not answer these questions, but it will suggest that the responses that have been given by many economists over the past few decades are inadequate and possibly quite poor advice to decision-makers.

Date: 1999
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