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Recent blueprints for international monetary reform have called for a restoration of fixed or tightly managed exchange rates, with greater international monetary cooperation. But the conditions that allowed previous fixed-rate regimes to succeed no longer exist, Alberto Giovannini told a CEPR lunchtime meeting on 4 November. Previous systems had relied on the leadership provided by a dominant `centre country', but there was no country likely to play this role in the 1990s. Alberto Giovannini is Associate Professor of Economics at the Graduate School of Business, Columbia University, and a Research Fellow in CEPR's International Macroeconomics programme. He is co-editor of A European Central Bank? Perspectives on Monetary Unification after Ten Years of the EMS, to be published by Cambridge University Press for CEPR in April 1989. The research on which his talk was based, reported in CEPR Discussion Paper No. 282, was supported by the Ford Foundation and the Alfred P Sloan Foundation.Flexible exchange rates are frequently blamed for the large current account imbalances of the 1980s. All the proposed reform `blueprints' call for central bankers to `tie their own hands' in order to meet agreed exchange rate targets and to improve monetary policy coordination over that achieved through the Plaza, Tokyo and Louvre agreements. In Discussion Paper No. 282, Giovannini analysed the institutional set-up and behaviour of the three previous experiments with fixed exchange rates: the international gold standard, the Bretton Woods system and the European Monetary System. There are two competing interpretations of fixed exchange rate regimes. The `symmetry' hypothesis states that every country participates in the system on an equal footing and is concerned with avoiding sterilizing balance of payments flows. A `nominal anchor' to determine the level of prices is provided by an external numéraire such as gold, or is agreed upon by member countries through a process of international cooperation. The competing hypothesis states that fixed exchange rate regimes are inherently asymmetric, with a `centre country' that provides the system's nominal anchor either by managing the gold parity in a centralized fashion or by arbitrarily setting some other nominal target, such as its domestic rate of price inflation. Whether a fixed exchange rate system is symmetric or asymmetric can be determined by examining its adjustment to international disturbances. According to the symmetry hypothesis, disturbances, even if country-specific, should be accommodated by all countries in the system. Speculative pressure on the DM-franc exchange rate, for example, should be followed by a monetary expansion in Germany and a monetary contraction in France. By contrast, in a system dominated by a centre country the burden of international adjustment is imposed entirely on the countries at the periphery. Giovannini first studied whether the rules governing the operation of these three regimes were designed to induce symmetry or asymmetry, but he found nothing in their institutional set-up that seemed designed to encourage their asymmetric operation. His analysis of the operation of the three systems, however, suggested that they all operated asymmetrically, with one country, respectively Great Britain, the United States and West Germany, running monetary policy for the rest of the system and the others simply accommodating the centre country's policies. Giovannini found evidence to support the asymmetry hypothesis in his analysis of interest rate movements during international crises under the Bretton Woods system and the EMS: US and German interest rates showed little movement before exchange rate realignments. Under the gold standard, British discount-rate policies were determined by movements in the ratio of gold reserves to liquid liabilities at the Bank of England, not by international flows of gold. Discount rates in peripheral countries such as Germany and France were, by contrast, systematically affected by international gold flows. Further evidence is provided by asymmetric recourse to capital controls, which have been much more frequently imposed by countries at the periphery, in order to avoid politically unacceptable costs of adjustment. The historical evidence therefore suggested that, in practice, if all countries participate on an equal footing they find it extremely difficult to allocate the burden of international adjustment. The viability of asymmetric systems may confirm Mundell's finding that if one economy is very large all countries can gain if it sets monetary policy for the whole system; or that all gain if the centre country has a reputation as an inflation fighter. What are the lessons for exchange rate policies in the 1990s? Giovannini argued that in Europe the conditions that made the EMS viable are slowly disappearing, with the full integration of financial markets by 1992, the likely enlargement of the EMS and the convergence of inflation rates. He found little historical evidence to support the `optimistic view' that full financial market liberalization will force monetary authorities to coordinate policies internationally. In times of crisis central banks have resorted to temporary abrogation of the `rules of the game': during the gold standard the Bank of England three times suspended the convertibility of banknotes into gold, and during the Bretton Woods and EMS years countries have resorted to a variety of regulations to stem speculative flows. As there is no evidence to suggest that countries will surrender their monetary sovereignty, central banks would still have the option of temporarily invalidating the agreed international arrangements. Outside Europe, Giovannini's analysis cast doubt on the feasibility of current proposals for international monetary reform. He argued that the 1990s would be a time of `multi-polarity' in the world political and economic system, in which neither the United States, Japan or the EC would dominate. All the blueprints for reform proposed forms of symmetric exchange rate regime, which were unlikely to survive significant international shocks. Giovannini suggested that a more fruitful area could be greater coordination among the industrialized countries of financial market regulation and capital income taxation. Such coordination would ensure a more orderly functioning of international financial markets and might avoid the apparently inexplicable exchange rate fluctuations of the 1980s. |