Abstract

Stability-consonant Fixed Exchange Rate Systems

The debate on “fixed versus flexible exchange rates” suffers from the fact that when speaking of “fixed exchange rates” most authors presuppose a fixed exchange rate system having essentially the nature of the unsuccessful Bretton Woods system. In this study it is shown that fixed exchange rate systems can also be so designed that the main system defects of Bretton Woods are avoided. The point of departure taken for the conception of a “stability-consonant fixed exchange rate system” is a proposal by MceKinnon (1984) and the plan of a “hardened foreign exchange standard” introduced into the debate by the German Council of Economic Experts in its annual report 1966/67. A fixed exchange rate system as visualized by McKinnon would differ from the Bretton Woods system above all in that the participating central banks would pursue a common objective for the “world money supply” (M1). A stability-consonant growth rate of the world money supply would thus be ensured even in the event of extensive (direct or indirect) currency substitution. The disadvantage of this proposal lies in the fact that it allows extensive discretionary leeway to those central banks which pursue a less stability-consonant policy than the other participating countries. The “hardened foreign exchange standard”, on the other hand, is characterized by the fact that countries with an inflationary economic policy course are compelled quite automatically to adjust to the countries witha stability-oriented policy. This isensured under the “hardened foreign exchange standard” by the participating countries being obligated to intervene only when their own currency is weak (exclusive intervention obligation at foreign exchange surrender point). Hence this type of fixed exchange rate system differs substantially from the Bretton Woods system (and also from McKinnon’s plan), in which central banks with strong currencies were always obliged in a weakdollar phase to buy unlimited amounts of dollars. The risk of the “hardened foreign exchange standard” lies in its inflationary bias. If this is to be counteracted, it is advisable to combine this type of fixed exchange rate system with a common target for the sum of the monetary bases of the participating countries as proposed by McKinnon.