Working Paper: NBER ID: w2464
Authors: Rudiger Dornbusch; Jeffrey Frankel
Abstract: We review ten aspects of how floating exchange rates have worked in practice, contrasted with ten characteristics that the system was supposed to have in theory. We conclude that the foreign exchange market is characterized by high transactions-volume, short-term horizons, and an absence of stabilizing speculation. As a result, the exchange rate at times strays from the equilibrium level dictated by fundamentals, contrary to theory. We then look at ten proposed alternatives to the current system. Four entail decentralized policy rules: new classical macroeconomics, a gold standard, monetarism, and nominal income targeting. Four foresee enhanced international coordination: G-7 "objective indicators," Williamson target zones, McKinnon "world monetarism," and a "Hosomi Fund." Two propose enhanced independence: a "Tobin tax" on transactions, and a dual exchange rate. We conclude that one might build a case for intervention from the observed failure of international financial markets to behave as in the theoretical ideal, but that government intervention in practice is just as likely to fall short of the theoretical ideal
Keywords: exchange rates; floating rates; international monetary system
JEL Codes: F31; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| psychological market behavior (G41) | increased volatility in exchange rates (F31) |
| anticipated effectiveness of interventions (I24) | actual outcomes (P47) |
| speculation behavior (D84) | stability of exchange rates (F31) |