A remarkable feature of the last hundred years of international monetary history is the regularity with which fixed and flexible exchange rate regimes have succeeded one another. The academic literature provides many studies of particular episodes, but we have few general explanations for such shifts. In Discussion Paper No. 812, Research Fellow Barry Eichengreen reviews six hypotheses advanced to account for the pattern of exchange rate regimes over the last century.

First, fixed exchange rates may require international economic leadership, since foreigners get part of the benefits of each country's contribution to stability, which therefore tends to be undersupplied. If one country is large enough to reap the lion's share of the benefits, it will willingly bear a disproportionate share of the burden and internalize these externalities. Second, maintaining international monetary stability may require regular international cooperation by governments and central banks, even if no country provides hegemonic dominance. Third, intellectual consensus is a prerequisite for a fixed-rate regime, since national policy-makers must agree collaborative measures for cooperation to take effect; a common model facilitates `regime-preserving cooperation'. Fourth, underlying macroeconomic stability itself helps to preserve fixed-rate systems. When macroeconomic disturbances are large, defending the exchange rate peg may require draconian domestic policies that will exacerbate already high unemployment. Fifth, if a fixed-rate regime acts as an anti-inflationary rule, shifts between regimes reflect the changing costs and benefits of adhering to such a rule; these depend in turn on the level and variability of government expenditure. Sixth, domestic distributional politics may play a role, as the balance of power shifts between interest groups that favour and oppose either regime.

Eichengreen finds evidence to support several of these hypotheses and concludes that no explanation based on a single cause is likely to prove adequate. The integration of these competing theories will require further research.

The Endogeneity of Exchange Rate Regimes
Barry Eichengreen

Discussion Paper No. 812, July 1993 (IM)