Abstract

Exchange Rate Instability and the Hard Currency Option: The Role of the D-Mark in the Future EMS

By "choosing" between alternative exchange rate systems one cannot escape fundamental problems. In flexible-exchange-rate systems especially leading currencies at times are exposed to distortions of relative competitiveness which stem from nominal exchange rates being governed by capital movements. Attempts to maintain substantial current account imbalances by inducing appropriate capital flows add to the instability in foreign-exchange markets. In systems with fixed nominal exchange rates requirements of maintaining external equilibrium will dominate internal economic policy decisions. The concepts of monetary harmonization in Europe seem to aim at lowering these external constraints; some countries may hope that German monetary policy can be neutralized. However, temporary balance-of-payments problems in the EMS do not stem from the so-called "hardline" course of the Bundesbank, but rather from spells of preferences in favour of the D-Mark in connection with chronic German export surpluses. The latter should be lowered by means of a substantial revaluation of the D-Mark and not by expansive economic policy. For this proposal to be realized the FRG would be forced to abandon its welfare-by-export strategy, to rely on terms-of-trade gains instead, to pursue a hard-currency policy and to adopt the position of a mature creditor country.