Exchange rate flexibility

[Front Matter and Conference Information]: The front matter for the 1978 conference volume 'Exchange Rate Flexibility', including the title page, publication metadata, and a dedication to Harry G. Johnson and Egon Sohmen. It establishes the joint sponsorship of the American Enterprise Institute and the U.S. Department of the Treasury. [List of Participants]: A comprehensive list of participants for the conference, featuring prominent economists, bankers, and government officials from institutions such as the IMF, U.S. Treasury, Federal Reserve, and various universities. [Table of Contents]: The table of contents outlining the five parts of the volume: evaluation of floating rates, the foreign exchange market, trade and investment, international guidelines/IMF roles, and international liquidity. [Foreword]: Thomas D. Willett provides the background for the conference, noting the breakdown of adjustably pegged rates and the adoption of flexibility. He discusses the collaboration between the Treasury and AEI, the importance of bridging the gap between practitioners and researchers, and the consensus that flexible rates are superior to pegged rates under current conditions. [Introduction and Summary]: An overview of the conference's five sessions. It summarizes debates on exchange rate volatility (Bernstein vs. others), the efficiency of the foreign exchange market (Rutledge, Sweeney, Schmidt), the impact on multinational business and accounting (Burns, Teck, Burtle), and the evolution of international surveillance and IMF principles (Cross, Yeo). The summary highlights a general consensus that while floating is not perfect, it outperformed the expectations of its critics. [Part Five: International Liquidity under Flexible Exchange Rates]: This section introduces Part Five of the conference, focusing on international liquidity under flexible exchange rates. It summarizes presentations by Robert L. Slighton and comments from various academic and banking experts, concluding that international liquidity management should be approached through international surveillance of the adjustment process. [The Economics of Fluctuating Exchange Rates]: Edward M. Bernstein discusses the fundamental functions of exchange rates as a link between national and world economies. He argues that the primary function of the exchange rate is to facilitate international trade and capital flows based on comparative costs and interest rates, asserting that floating rates are more likely to achieve an appropriate balance of payments in an unstable world where countries cannot maintain the price stability required for fixed parities. [Three Years of the Floating Dollar]: Bernstein evaluates the performance of the floating dollar since 1973, noting that while the system has successfully cleared markets without major crises or heavy intervention, it has also experienced large fluctuations driven by speculative capital flows rather than underlying economic conditions. He critiques trade-weighted averages as measures of competitive position, arguing they often fail to account for domestic inflation differentials and the specific impact of industrial country exchange rates. [Economic Effects of Excessive Fluctuations]: This section analyzes how excessive exchange rate fluctuations distort the pattern of trade, particularly in manufactured goods, and create haphazard effects on national economies. Bernstein highlights an asymmetrical inflationary effect: while currency depreciation promptly raises domestic prices and costs (often leading to permanent wage increases), subsequent appreciation does not moderate those costs as fully or quickly. [Should Fluctuations in Exchange Rates Be Dampened?]: Bernstein explores the debate over central bank intervention to dampen exchange rate volatility. He argues that while determining an 'appropriate' rate is difficult, intervention to reduce extreme divergences is economically beneficial. He cites European concerns, such as those of Chancellor Helmut Schmidt, and the Rambouillet agreement as evidence of a growing international consensus on countering disorderly market conditions and erratic fluctuations. [The IMF and Fluctuating Exchange Rates]: Bernstein discusses the role of the IMF in supervising exchange rate policies under the amended Article IV. He reviews guidelines proposed by the Committee of Twenty for intervention and suggests a pragmatic U.S. policy: allowing market forces to adjust rates for underlying conditions while intervening to limit rapid, speculative movements (e.g., limiting movements to 1-2 percent per month after an initial significant shift). [How Floating Exchange Rates Are Working: A European View]: Josef Molsberger provides a European perspective on the transition from Bretton Woods to floating rates. He defends floating against critics who blame it for disintegration, arguing that the previous fixed-rate system was actually a system of 'adjustable pegs' with an inherent inflationary bias. He asserts that exchange rates are merely indicators of underlying economic policy divergences, particularly regarding domestic price stability. [International Coordination and Exchange Controls]: Molsberger refutes the claim that floating ended international coordination or increased exchange controls. He provides evidence that major trading countries (USA, Germany, France, Italy) actually relaxed capital controls after adopting floating rates. He argues that instances of tightened controls, such as in West Germany, were often due to the retention of fixed rates within the European 'snake' rather than floating itself. [Market Self-Steering and Spontaneous Order]: Molsberger discusses the psychological and political resistance to market-determined exchange rates. Invoking Hayek's concept of 'spontaneous order,' he argues that the 'ruleless' nature of floating is actually a form of market pricing. He notes that 'managed floating' often reintroduces the political contentions of the fixed-rate system by making exchange rate levels a matter of government decision rather than market outcome. [Has Floating Impeded International Trade?]: Molsberger examines whether floating rates have hindered international trade. He points out that world trade grew significantly in 1973-1974 despite volatility. He argues that trade-weighted averages show much less instability than individual currency pairs and that the private sector has successfully utilized forward markets, foreign currency loans, and insurance (like Hermes in Germany) to manage exchange risks. He concludes that floating is a superior 'second best' solution compared to fixed rates with non-coordinated policies. [Floating, Inflation, and the Autonomy of National Monetary Policy]: The final section addresses the claim that floating failed to provide monetary autonomy. Molsberger refutes the 'perverse reaction' theory (where depreciation supposedly fails to improve trade balances), arguing that trade imbalances in countries like Italy and the UK were caused by domestic inflation and labor strikes rather than the exchange rate system. He concludes that floating provides autonomy for stability-oriented policies and forces inflationary countries to 'swallow' their own inflation, potentially creating a long-term anti-inflationary bias. [Conclusion: Realism and the Future of Floating]: The concluding remarks of the preceding section argue that while floating exchange rates are not a perfect solution, they are appropriate for the current global economic reality. It includes a quote from Austrian Treasury Minister Androsch satirizing the impossible expectations for a perfect currency system and calls for a realistic acceptance of the floating regime. [The Behavior and Effects of Flexible Exchange Rates: A Brief Review of Recent Research]: Thomas D. Willett summarizes technical research on exchange rate flexibility, arguing that floating rates have performed better than expected despite not granting full policy independence. He addresses criticisms regarding trade imbalances, world inflation, and market volatility, concluding that volatility often reflects underlying policy instability rather than market inefficiency. He further discusses the theory of optimum currency areas, noting that high capital mobility makes compromise systems like the adjustable peg less viable than relatively free floating. [Commentary by C. Fred Bergsten]: C. Fred Bergsten presents two hypotheses and one concern regarding floating rates. He argues that flexible rates are anti-inflationary by forcing countries to internalize inflation and reducing the need for world liquidity. He also suggests a correlation between exchange rate valuation and the patterns of foreign direct investment by multinational firms. His primary concern is the risk of competitive depreciation in a unilaterally managed system, advocating for multilateral management and IMF surveillance. [Commentary by Gottfried Haberler]: Gottfried Haberler synthesizes the points of agreement and disagreement among the panelists. He notes consensus on the unavoidability of floating, the persistence of pegged currencies, and the increased risk for speculators. He distinguishes between monetary disturbances (which floating protects against) and real disturbances (which it does not). He expresses skepticism toward numerical rules for official intervention, suggesting that governments have a dangerous propensity to intervene excessively. [Commentary by Harry G. Johnson]: Harry G. Johnson critiques Bernstein's views on the composition of the balance of payments and the use of exchange rates to target specific industrial markets. He challenges the assumption of downward wage stickiness and argues that the risks of competitive devaluation are overstated in a floating system compared to the 1930s. He concludes that while the floating system is imperfect, there is no clear way to improve it through intervention without better understanding market dynamics. [Summary of Discussion: Appraisal of Floating Rates]: This section summarizes the general discussion following the papers. Robert Mundell argues against the superiority of floating rates, citing the deterioration of the global economy post-1971 and questioning the link between floating and oil deficit financing. Other discussants, including Bernstein and Molsberger, defend the performance of floating rates as the best available alternative. Robert Solomon provides data on the distribution of world reserves, noting that the growth in liquidity was largely concentrated in OPEC countries. [Summary of Discussion: Causes and Welfare Implications of Fluctuations]: The discussion continues with an analysis of exchange rate volatility. Sven Arndt and Walter Salant explore choice-theoretic models and asset preference shifts as explanations for fluctuations. Egon Sohmen argues that interest arbitrage and purchasing power parity explain the mark-dollar rate. The debate shifts to the welfare implications of these movements, with Bernstein advocating for intervention to dampen 'excessive' swings, while Willett and Molsberger emphasize market efficiency and the availability of forward cover. The section concludes with remarks on the role of central banks and the inevitability of market-driven rates. [Part Two: The Foreign Exchange Market Under Flexible Exchange Rates]: Introduction to Part Two of the volume, featuring a report by John Rutledge based on interviews with West Coast foreign exchange dealers to provide an economist's view of market operations. [An Economist's View of the Foreign Exchange Market: Report on Interviews with West Coast Foreign Exchange Dealers]: John Rutledge reports on the technical efficiency of foreign exchange markets based on interviews with West Coast dealers. He examines the role of private speculators in transmitting information and evaluates the 'bandwagon effect' hypothesis, concluding that such effects are primarily intraday phenomena rather than long-term cycles. The segment also addresses whether the market is 'thin' and the impact of institutional constraints on stabilizing speculation. [Report on Technical Studies on Speculation and Market Efficiency]: Richard James Sweeney reviews technical studies on market efficiency, contrasting the views of R.M. Goodwin and Milton Friedman on the stabilizing role of speculators. He details 'weak-form' tests, including correlation tests and filter rules, applied to the Canadian-U.S. dollar and DM-U.S. dollar rates. The analysis highlights the difficulty of distinguishing between inefficient cycles and efficient shifts in underlying trends, ultimately finding the results consistent with market efficiency. [Foreign Exchange Intervention by the Federal Reserve Bank of New York: Some Questions]: Wilson E. Schmidt examines the mechanics and rationale of Federal Reserve intervention in the foreign exchange market since 1973. He discusses the use of swap agreements, the various 'styles' of intervention (from secret to public), and the ambiguity surrounding the definition of 'disorderly markets.' The paper questions whether intervention might have perverse effects, such as increasing uncertainty or creating rumors, and argues against rigid rules for central bank management. [Commentaries on Market Efficiency and Intervention]: A series of commentaries from practitioners and officials. Horst Duseberg discusses the increased risk under floating rates and the impact of the Herstatt failure. Nicolas Krul argues that exchange markets are inherently disorderly due to the unpredictability of rates and limitations in forecasting. Scott Pardee outlines the Federal Reserve's unique position and its use of swap lines. Dennis Weatherstone emphasizes the importance of timing and the logical behavior of markets in 1975 compared to earlier years. [Summary of the Discussion: Part Two]: A summary of the floor discussion following the papers in Part Two. Key topics include the existence of bandwagon effects, the definition of market efficiency (technical vs. economic), the feasibility of intervention in forward markets, and the criteria for evaluating intervention success (profitability vs. social welfare). The debate also covers the tension between the need for official confidentiality and the benefits of public disclosure of policy information. [The Economic Implications of Existing Accounting Standards]: Joseph M. Burns analyzes the discrepancy between accounting data and economic values, specifically regarding the new standards for multinationals (FASB Statement No. 8). He argues that historical cost accounting induces nonoptimal managerial decisions and distorts resource allocation. Burns advocates for 'economic value accounting' as a means to provide more accurate financial data in an environment of inflation and price uncertainty, despite the practical difficulties of implementation. [Exposure Management Under Floating Rates]: Alan Teck traces the evolution of exposure management from the early Bretton Woods era to the floating rate period. He details how the 1967 sterling devaluation shifted corporate focus toward currency risk. The paper explains the distinction between translation and transaction exposure and how FASB Statement No. 8 has impacted corporate behavior, often increasing reported profit volatility and discouraging prudent hedging of anticipated transactions and inventories. [Conclusion: The Inevitability of Floating Rates]: The concluding section of the previous chapter argues that the massive volume of liquid resources held by private markets makes a system of floating exchange rates inevitable. It notes that while U.S. multinational companies have adjusted to the system, challenges remain regarding currency exposure and accounting standards like FAS No. 8. [The Reaction of Business to the Floating Rate System]: James Burtle and Sean Mooney evaluate the business experience under floating rates since 1973. They argue that while empirical data on trade and investment is inconclusive due to external shocks like the OPEC oil crisis, surveys of business executives suggest a pragmatic acceptance of floating rates as the only viable alternative to the instability of the late Bretton Woods system. [Comparative Costs and Management Trends under Floating Rates]: This section examines the increased costs associated with the flexible rate system, including higher demand for forward cover and internal management expenses. It highlights a significant trend toward the centralization of foreign exchange risk management within multinational corporations and uses the examples of the deutsche mark and Mexican peso to illustrate the psychological shift from 'ulcers' (floating) to 'apoplexy' (fixed rate devaluations). [Commentary: Donald Kirk on FASB No. 8 and Earnings Volatility]: Donald Kirk of the FASB defends Statement No. 8, arguing that accounting standards should reflect the economic reality of floating rates rather than artificially smoothing earnings. He discusses the limitations of the historical cost model and critiques Joseph Burns's preference for current value accounting, suggesting it might actually increase reported volatility. [Commentary: Geoffrey Bell on Market Stability and Investment]: Geoffrey Bell observes that exchange rate volatility has diminished as banks take smaller positions and improve forecasting. He discusses the integration of Eurodollar and domestic interest rates, the role of central banks as lenders of last resort in Euro-markets, and how companies are using matching assets/liabilities and parallel loans as alternatives to expensive forward cover. [Commentary: Dennis E. Logue on Corporate Valuation and Risk Models]: Dennis Logue applies the Capital Asset Pricing Model (CAPM) to international finance, arguing that efficient markets 'pierce the veil' of accounting changes. He suggests that because investors only reward systematic risk, firms should not over-hedge or spend excessive resources on exchange rate forecasting, except to prevent the specific costs of bankruptcy. [Summary of Discussion: Accounting and Real Effects]: This discussion summary covers the debate over FASB No. 8's impact on management behavior and the real costs of exchange rate volatility. Participants like Robert Roosa and Joseph Burns debate whether accounting 'straddles' waste resources, while Robert Heller questions why the business community remains passive despite the potential for exchange rates to distort resource allocation. [Interpreting the Rambouillet and Jamaica Agreements]: Under Secretary Edwin Yeo III explains the U.S. Treasury's perspective on the Rambouillet and Jamaica agreements. He emphasizes that stability must come from underlying economic factors rather than intervention, critiques the 'target rate' approach as a 'nonsystem,' and argues that the current floating regime possesses a built-in, albeit sometimes abrupt, discipline. [The Role of the IMF under the Amended Articles of Agreement]: Sam Y. Cross describes the new IMF Article IV, which legalizes floating rates while providing for 'firm surveillance' by the Fund. He explains that the focus has shifted from maintaining specific exchange rate regimes to ensuring that members promote underlying economic stability and avoid manipulating the system for unfair advantage. [Commentaries on IMF Surveillance and National Policies]: A series of commentaries by leading economists on the practicalities of IMF surveillance. Thomas de Vries and Fred Hirsch argue for more explicit exchange rate norms or 'target zones,' while Armin Gutowski emphasizes the need for stable national monetary and fiscal targets. J.J. Polak discusses the 'correct' exchange rate as a medium-term equilibrium, and Marina Whitman explores the levels of international policy coordination. [Rejoinder and Summary: The Feasibility of Equilibrium Rates]: Sam Cross responds to the commentaries, expressing skepticism about the ability of international bodies to determine 'correct' equilibrium rates. The subsequent discussion summary features John Karlik's view of the Jamaica Agreement as an endorsement of an inconvertible dollar standard and Robert Roosa's suggestion that the European 'snake' serves as a useful experiment for selective fixity. [International Liquidity Issues under Flexible Exchange Rates]: Robert Slighton examines whether international liquidity remains a problem under floating rates. He addresses three critical hypotheses: that reserve growth is uncontrolled and inflationary, that borrowing is too easy for deficit countries, and that private capital mobility undermines national monetary policy. He concludes that the Eurocurrency market's role in inflation is exaggerated and that IMF conditionality remains the key to orderly adjustment. [Commentaries on Liquidity: Aschinger, Machlup, and Salant]: Franz Aschinger critiques the 'benign neglect' of liquidity, arguing that the 1970-73 reserve explosion fueled hyperinflation. Fritz Machlup argues that reserve creation must be brought under international control and proposes a gold substitution account with a declining gold-to-SDR ratio. Walter Salant suggests that the increase in OPEC reserves reflects a shift in wealth to those with a high propensity to hoard, which is not necessarily inflationary. [Commentaries on Liquidity: Schmitz, Sohmen, and Triffin]: Wolfgang Schmitz argues that the lack of liquidity control encourages deficit countries to avoid adjustment. Egon Sohmen posits that the importance of international liquidity is overrated and that the Eurodollar market is not an 'inflation machine.' Robert Triffin laments the abandonment of the Committee of Twenty's reform proposals, arguing that the Jamaica Agreement fails to address the erratic and biased process of reserve creation. [Summary of Discussion: The Control of Liquidity]: The final discussion summary addresses the need for liquidity control. J.J. Polak notes that the reserve explosion ended in 1973, while Fred Hirsch frames liquidity as a 'collective-good' problem requiring strict rules. Robert Heller warns that OPEC spending will eventually become inflationary, and Gretchen Greene suggests that exchange rate movements are driven more by increased velocity of funds than by the aggregate volume of liquidity. [Postscript: Issues in Exchange Rate Flexibility]: Jacob Dreyer provides a final assessment of the floating rate regime. He concludes that charges of market inefficiency and excessive welfare costs are largely unsupported by empirical evidence. He argues that exchange rate fluctuations reflect unstable underlying conditions rather than market defects and that official intervention is generally the least efficient method for achieving stability.