September 19, 2000
|Contact:||John Williamson||(202) 328-9000|
Washington, DCIt is a mistake for emerging market economies to be forced to choose either a currency board or a floating exchange rate ("at most lightly managed"), despite widespread advice from the US Treasury, the G-7, the International Monetary Fund, and many academic economists that they do so. A new Institute study, Exchange Rate Regimes in Emerging Markets: Reviving the Intermediate Option, by Senior Fellow John Williamson, concedes that currency boards and freely floating rates are less likely to generate crises than intermediate regimes. However, Williamson argues that it is wrong to imagine that these regimes preclude crises. Moreover, both of the consensus approaches are more prone than intermediate regimes to generate currency misalignments-large and prolonged deviations of exchange rates from levels justified by economic fundamentals. Competitive exchange rates are widely recognized to have been one of the key foundations for the East Asian miracle, accordingly, discouragement of policies that can maintain competitive rates could preclude resumption of East Asia's past stellar economic performance and successful development of Latin America and other emerging markets.
When countries are told they must choose between the consensus options, most resort to fairly heavily managed floating. However, this approach has two disadvantages: its lack of transparency raises the risk of conflicting behavior between different countries, and it fails to provide a focus for expectations that might make private speculation more stabilizing.
Williamson asks whether it might be possible to find an alternative regime that would perform better on these counts. He concludes that a promising solution is a publicly announced "monitoring band", a range:
This strategy would provide information to the markets as to what rate the authorities believe to be consistent with long-term fundamentals and hence where they should expect official action to limit misalignment. This should help stabilize market expectations. It would not impose an obligation on the authorities to defend a Maginot line, however, so should be immune from the crises that have plagued intermediate regimes. (Williamson's support for intermediate regimes of course does not extend to the traditional adjustable peg, a system that was abandoned by all well-managed countries many years ago.)
Emerging market countries will have to live with more flexible exchange rate regimes than in the past. But exchange rates are too important to be left to foreign exchange traders so countries should not be expected to ignore them. Hence it is lamentable that the IMF is pushing countries into one of the two extremes. It should instead encourage them to adopt monitoring bands or a similar intermediate regime, avoid prolonged and substantial misalignments, and focus market expectations on a range of rates that make sense in terms of the medium-term fundamentals.
1. Alternative possibilities would be a reference rate or a crawling band with soft margins, perhaps taking the form of a requirement to keep the medium-term average of the market exchange rate within a band.