Essay about Floating Exchange Rates: The Only Viable Solution

Essay about Floating Exchange Rates: The Only Viable Solution

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Floating Exchange Rates: The Only Viable Solution

For some, the collapse of Mexico's economy proves that floating exchange rates
and markets without capital controls are deadly. Others find the crash of the
European exchange-rate mechanism (ERM) in 1993 to be proof that targeted rates
will always be overturned by the free market. Many see the breakup of Bretton
Woods as the failure of fixed rates. Yet others believe monetary unification in
Europe is the only way to achieve economic and political stability. Many others
hold still different beliefs. There are, however, four main proposals for the
management of international currency exchange rates: monetary unification, fixed
rates, floating rates maintained within certain "reasonable" limits of
variability and freely floating rates. Both fixed exchange rates and rates based
on either explicit or unwritten targeting are impossible to maintain, especially
in an era of free trade. Complete monetary unification would be impossible to
bring about without extensive integration and unification of international
governments and economies, a task so vast that it is unlikely ever to be
accomplished. Thus, the only option central banks have is to allow exchange
rates to float freely.

The European Monetary System, which virtually collapsed in 1993, was an attempt
to fix exchange rates within certain tight bands, to coordinate monetary policy
between member nations and to have central banks intervene to keep exchange
rates within the bands when necessary. The reasons for the collapse were myriad,
but, simply put, it happened because Germany, dealing with financial problems in
part arising from its reunification, refused to lower its high interest rates.
This meant other European countries either had to keep their rates equally high
and allow themselves to fall into recession as a result, or devalue their
currency against the mark, a move viewed by many as a political embarrassment.
The possibility of a devaluation caused speculators to bolt from the lira, the
pound, the franc and other currencies, sending the markets into chaos and
destroying all semblance of stability. In the end, the ERM was adjusted to allow
currencies to fluctuate within 15 percent on either side of their assigned level,
up from (in most cases) a limitation of 2.25 percent. The bands became too wide
to be...

... middle of paper ...

...ange Rates. Ed. Leo Melamed.
Fairfax, Virginia: George Mason University Press, 1988. xix-xxv.

Habermeier, Karl and Horst & Ungerer. "A Single Currency for the European
Community." Finance & Development September 1992: 26-29.

Hoffman, Ellen. "One World, One Currency?" Omni June 1991: 51+.

Hornblower, Margot. "No One Ever Said It Would Be Easy." Time 1 March 1993: 32+.

"Interview with Alan S. Blinder." The Region December 1994. Online. Kimberely.

Javetski, Bill and Patrick Oster. "Europe: Unification for the Favored Few."
Business Week 19 September 1994: 54.

Krugman, Paul R. "Europe's Fatal Monetary Vision." U.S. News And World Report 16
August 1993: 45.

Lawday, David and Warren Cohen. "Capsizing Currencies." U.S. News And World
Report 16 August 1993: 43-45.

Lewis, Flora, et al. "Is Monetary Union a German Racket?" New Perspectives
Quarterly Winter 1993: 26-38.

Lewis, Paul. "Role Shifts for Central Bankers." The New York Times 15 November
1994: D1.

Magnusson, Paul. "The IMF Should Look Forward, Not Back." Business Week 3
October 1994: 108.

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