The Art of Monetary Policy

By David C. Colander; Dewey Daane | Go to book overview

15

FRANCIS H. SCHOTT*


Fixed Versus Fluctuating Exchange Rates

Fixed versus fluctuating exchange rates is a perfect topic for any economist from one very important point of view--it is a hardy perennial. One can write a term paper, master's thesis, doctoral dissertation, or book on the topic without fear of being out of date. You can also sell yourself as a relevant person to any private or government employer dealing with international affairs by having worked on this topic, a decade ago, now, or most likely a decade from now.

The reason is simple yet profound. We know from Adam Smith and David Ricardo that specialization, including that across borders, enhances productivity and potential world welfare. We also know that the optimum currency area is a single world because the implicit factor mobility and absence of currency risk maximize specialization and productivity.

These theoretical observations clash with a world of nation-states, in which currency autonomy is a key attribute of sovereignty. Thus, a single world currency--no exchange rates--is theoretically best, and fixed exchange rates without currency restrictions second-best, in max

____________________
*
It is an honor as well as a pleasure to contribute to this book in honor of Alan Holmes. I believe I can claim to have been one of Alan's earliest and longest-time friends at the Federal Reserve. He was there as an economist when I joined in 1951 and had advanced to manager of the Federal Reserve Open Market Account when I left in early 1967. Everyone benefited from Holmes's booklet, The New York Foreign Exchange Market ( 1959), which was the first description and analysis since World War II of a fairly freely functioning private foreign exchange market. I was privileged to be Alan's coauthor in the revised and expanded version of that booklet in 1965. In effect he was my mentor. To this day, people tell me how they cut their teeth of international economics knowledge on that booklet.

-187-

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