Unexpected Real Consequences of Floating Exchange Rates

Abstract

After a decade of floating exchange rates, international monetary reform is again in the air, and it is thus timely to ask how well (or badly) the current system is functioning. But compared to what? Because the current monetary arrangements came into effect following years of vigorous debate on the merits of exchange rate flexibility, some observers appear to forget that these arrangements were not in reality ‘adopted’, let alone ‘designed.’² Rather, they were initiated by the collapse of the Bretton Woods regime and given markedly after-the-fact approval by an International Monetary Fund whose members were unable to agree upon an alternative, i.e. any system imposing even minimal restraints on the national policies of members. Since the present time seems no more propitious than the early 1970s for the willing sacrifice of national sovereignty by IMF members,³ any argument for system reform must be solidly grounded in the accumulated experience of floating, not the dogmas of the Bretton Woods era.

This paper was prepared for the Wingspread Conference on the Evolving Multiple Reserve Asset System, July 28–30, 1982. I am grateful to J. David Richardson for extensive and stimulating discussions of the subject. I am indebted also to Robert E. Baldwin, Peter B. Kenen, Charles P. Kindleberger, Michael Rothschild, Andre Sapir, Janet Yellen, and conference participants at Wingspread and the 1982 National Bureau of Economic Research Summer Institute for helpful suggestions, and to the University of Wisconsin Graduate School for financial support.