Objectives of the Chapter

This chapter laysout the foreign exchange regimes available to a country and explores somelessons of history about each of those regimes. Particular attention is paid tothe options open to a country that is trying to defend a fixed exchange rate.These range from intervention in the foreign exchange market to the impositionof exchange controls.

There is a simplebut real trade-off involved in choosing an exchange rate regime (other than thechoice of certainty versus uncertainty in the value of one’s currencyinternationally). With a fixed exchange rate, a country loses independentmonetary policy.  This is good insofar asmonetary authorities have an inflationary bias; it is bad insofar as thecountry might need stabilization tools. The reverse is true under a flexible exchange rate regime:  monetary authorities retain their power toaffect price levels -- for both good and evil!

After studyingChapter 20 you should know

     1.    the variety ofexchange rate policies countries have used.

     2.    how a country canrespond to pressure on the value of its currency.

     3.    the implicationsof temporary versus permanent imbalances in exchange rates.

     4.    the benefits andcosts of foreign exchange controls.

     5.    how fixed rateshave performed in the past.

     6.    how flexiblerates have performed in the past.