On 21 June CEPR launched a new book, on Blueprints for Exchange Rate Management. Published by Academic Press for CEPR and edited by Marcus Miller, Barry Eichengreen and Richard Portes, it is a wide-ranging evaluation of alternative proposals for international monetary reform and limiting exchange rate flexibility. Marcus Miller and Richard Portes assessed the prospects for international economic policy in light of the research contained in the new volume. Marcus Miller is Co-Director of the Centre's International Macroeconomics programme, and Richard Portes is Director of CEPR. Financial support for the meeting at which they spoke was provided by the Ford Foundation and the Alfred P Sloan Foundation, and by Academic Press.
In the mid-1980s, the agreements struck at the Plaza and at the Louvre put the subject of international monetary reform firmly on the political agenda. Recently, however, many have claimed that the tentative mechanisms for exchange rate management and policy coordination agreed at the Louvre have been irreparably damaged by the failure to reduce payments imbalances and by the renewed strength of the dollar. This has reopened the debate on international monetary reform. But the present turbulence in currency markets and disarray in G3 policy coordination are likely to be only temporary, according to Miller and Portes. Policy coordination would not be abandoned and would probably continue to be based on exchange rate management.
Miller sketched a scenario in which joint decision-making would evolve, encompassing not merely currency intervention but also agreement in setting interest rates in the G3. Their average level will be adjusted to restrain global inflation and their international differentials so as to defend targets for the Deutschmark/dollar and yen/ dollar rates. Although the historical evidence is that exchange rate regimes tend to asymmetry, Miller suggested that such an arrangement among the G3 may be plausible nonetheless and more attractive than a return to free floating.
Portes focused on the options for Europe. The EMS, he maintained, will continue to rest asymmetrically on the Deutschmark and on German monetary policy leadership, at least until sterling enters the Exchange Rate Mechanism. In order to manage the forthcoming difficult period of Spanish entry and the removal of capital controls, Portes advocated improving intervention procedures, developing joint reserve holdings, and deepening policy coordination as well as keeping up the momentum of monetary integration begun at Hanover and advanced by the Delors Committee report.
The Bretton Woods system of pegged-but-adjustable exchange rates broke down in 1973 because of increasing capital mobility and decreasing confidence in US counter-inflation leadership. Germany has since actively aimed to create a zone of monetary stability in Europe, and the EMS has evolved into a Deutschmark standard underpinned by confidence in Bundesbank leadership and to date by French and Italian capital controls. After a long flirtation with floating, the United States has returned to a policy of managing the dollar, orchestrating first the Plaza Agreement then the Louvre Accord. These were, however, essentially agreements for intervening in currency markets and did not signify global acceptance of US monetary leadership.
The experience of free floating since 1973 has been disappointing. Rates have moved far more in response to fundamentals than seems rational, and there have been unsustainably large payments imbalances. The ability of national monetary targets to supply a nominal anchor under floating has also been undermined by rapid financial deregulation. Many observers have responded with proposals for greater exchange rate stability. These have included McKinnon's plan for a symmetric `paper gold standard' of fixed exchange rates within the G3; the Williamson-Miller blueprint for exchange rate target zones, extended to incorporate a role for domestic fiscal policies; and Boughton's `disciplined floating', in which decentralized, national monetary targets continue to have a key role.
Miller and Portes noted that the debates of the 1980s have represented the confluence of two strands of thinking, the first on the benefits of coordinated macroeconomic policies in a world in which international policy spillovers and interdependence increasingly preoccupy national policy-makers, and the second on exchange rate stabilization. On one view, these debates are essentially the same because coordination can eliminate exchange rate misalignments; others point out that exchange rate variability can be caused by inefficiencies in foreign exchange markets, for example, and not just by macroeconomic policy shocks. Some argue that an exchange rate regime will help sustain policy coordination by committing authorities to policy rules on which they could not renege without losing credibility. Others view exchange rate stability as a desirable goal in its own right, but whether any given proposal for exchange rate stabilization could actually induce the most beneficial levels and behaviour of exchange rates is in doubt. Blueprints for Exchange Rate Management brings together relevant historical analysis, theoretical models and empirical testing.
In his chapter in the volume, George Alogoskoufis finds that although the McKinnon proposal may represent the `first-best' optimal regime when governments can deploy both monetary and fiscal policies as stabilization tools, it is unrealistic to assume that fiscal policies are sufficiently flexible to achieve such goals. The nominal exchange rate flexibility envisaged by Williamson appears to be needed in such a second-best world, though Alogoskoufis's analysis offers no justification for confining exchange rates within bands.
James Boughton disputes the usefulness of exchange rate targets to achieve external balance. He argues instead that national monetary policies should be assigned to stabilizing domestic nominal income and fiscal policy to a current account target. Exchange rates would float, disciplined by broad international agreements on fiscal policies and real interest rates. Alison Hook and David Walton explore whether commodity prices could supplement monetary targets as guides to policy. They find, however, that commodity price disturbances can reflect supply as well as monetary shocks, so the authorities would have to exercise an element of discretion and only react to commodity price disturbances that reflected the underlying state of demand.
Alberto Giovannini analyses three examples of fixed exchange rate regimes in practice, the interwar Gold Standard, the Bretton Woods system and the EMS. He finds evidence that all three operated `asymmetrically', with a dominant centre country, which retains its monetary policy independence and provides a nominal anchor for the system. This tendency towards asymmetry in fixed exchange rate regimes can be read as a cautionary tale: recent blueprints for exchange rate management involve symmetric arrangements among the leading industrial countries.
The volume also describes empirical simulations using global econometric models to reveal how various policy regimes might operate in practice. Using data from 1975 to 1986, David Currie and Simon Wren-Lewis compare the performance of Williamson and Miller's extended target zones proposal with the `disciplined floating' advocated in the volume by Boughton. They find that both regimes would have out-performed the policies actually carried out, and the extended target zones proposal best of all. Patrick Minford uses the Liverpool World Model to assess empirically whether monetary coordination as practised in the EMS could be beneficial. He argues that the EMS fails to deliver the full benefits of coordination, because its members can pursue incompatible macroeconomic policies. This defect could be overcome in a monetary union, in which national authorities would no longer have recourse to independent monetary policy, while considerable gains would come from reduced transaction costs.
Andrew Hughes Hallett, Gerald Holtham and Gary Hutson use the Federal Reserve Board's world econometric model to explore whether exchange rate targets can be used to obtain the benefits of full policy coordination. Their results suggest, pessimistically, that such a `surrogate' cannot substitute for full coordination. Paul Levine, David Currie and Jessica Gaines use the OECD's Minilink model to obtain results which suggest, more optimistically, that cooperative policies which are constrained to be `simple' can be effective and may even be easier to sustain.