Floating Exchange Rates Essay

2506 words - 10 pages

It Has A Bibliography. Very extensive research -Floating Exchange Rates: The Only Viable SolutionStentor SmithFor some, the collapse of Mexico's economy proves that floating exchange rates and marketswithout 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. Manysee the breakup of Bretton Woods as the failure of fixed rates. Yet others believe monetaryunification in Europe is the only way to achieve economic and political stability. Many others hold stilldifferent beliefs. There are, however, four main proposals for the management of internationalcurrency 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 basedon 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 andunification of international governments and economies, a task so vast that it is unlikely ever to beaccomplished. 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 exchangerates within certain tight bands, to coordinate monetary policy between member nations and to havecentral banks intervene to keep exchange rates within the bands when necessary. The reasons for thecollapse were myriad, but, simply put, it happened because Germany, dealing with financial problemsin part arising from its reunification, refused to lower its high interest rates. This meant other Europeancountries either had to keep their rates equally high and allow themselves to fall into recession as aresult, or devalue their currency against the mark, a move viewed by many as a politicalembarrassment. 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 ofstability. In the end, the ERM was adjusted to allow currencies to fluctuate within 15 percent oneither side of their assigned level, up from (in most cases) a limitation of 2.25 percent. The bandsbecame too wide to be meaningful or stabilizing, and the system remained alive 'in name only'(Whitney 19).Many saw this collapse as inevitable and say all attempts at government-imposed stability will fail:Governments both will not and cannot stick to pegged or fixed rates. First, maintaining targeted orfixed rates requires a consistent and fairly uniform monetary policy among nations. There are manyreasons that national governments will not consent to this, the foremost being that different countrieswant different things, different economies have different needs and different governments havedifferent policies. For example,...

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