FIXED EXCHANGE RATES
Until
the early 1970s and except during major wars, economically advancedcountries
typically maintained fixed nominal exchange rates among their currencies.
Figures 18.1 and 18.2 show that, from 1950 to the early 1970s, the nominal
exchange rates between six major currencies and the U.S dollar moved
infrequently and by small amounts compared to what came later. For the six
countries considered, the main exceptions to fixed nominal exchange rates in
this period were the fluctuations in the canadian dollar rate until the early
1960s and some realignments in the nominal exchange rates for the french franc,
german mark, and U.K pound.
In
chapter 17, we assumed an extreme form of fixed nominal exchange rates-an
environment where all countries used a common currency. Since there was only
one money, the fixity of nominal exchange rates had to hold. Within a country,
this arrangement is so use the same U.S dollar and, therefore,maintain a fixed
nominal exchange rate. However until recently, the typical setup for countries
was that each one had its own currency. An important exception since 1999-2001
is the euro, now use by 12 western european countries and likly to expand to
cover additional countries in europe. In earlier times, the main example of
common currencies were small countries that used another country’s currency or
shared a single currency. For example,
panama and ecuador use the U.S dollar, 12 countries in africa use the CFA
franc, which has been linked, aside from one devaluation, to the french franc
(since 1999,the euro) and 7 islanhs in the caribbean use the caribbean dollar,
which is linked to the U.S dollar.
The
fixed exchange rate regim that applied to most advanced countries from world
war II until the early 1970s was called the bretton woods system. Under this system, the participating
countries established narrow bands within which they pegged the nominal
exchange rate, Ɛ, between their
currency and the U.S dollar. Each country’s central bank stood ready to buy or
sell its currency and the U.s dollar. For example,the german central bank
(bundesbank) provided dollars for marks when households (or more
likely,financial institutions) wanted to reduce their holding of marks, and the
reverse when households wished to increase their holding of marks. To manage
these exchanges, each central bank maintained a stock of assets as international
reserves-for example, U.S currency or gold, or, more likely, interest-bearing
assets such as U.S. Treasury bills that could be readily converted into U.S
currency. Then the united states stood ready to exchange U.S dollars for gold
(on the request of foreign official institutions) at a fixed price, which
happened to be S35 per ounce. Thus, maintaining a fixed nominal exchane rate
with the U.S dollar, each country indirectly pegged its currency to gold.
Another
historical exampleof a system of fixed exchange rates is the classical gold
standard. In this setup, each central bank directly pegged its currency to gold
at a fixed rate of exchange. The united kingdom was effectively on the gold
standard from the early eigthteen century until world war I, except for a
period of suspension from 1797 to 1821 because of napoleonic wars. After
departing from the gold standart during world war I, the united kingdom
returned this system in 1026 but departed again during the great depression in
1931. The united states was on the gold from 1879 until trough of the great
depression in 1933, when the dollar price of gold was raised from S20.67 to
S35per ounce. Earlier periods involved a greater role for silver in the united
states. From an international perspective, the high point of the gold
standard was from 1890 to 1914.
Under
a gold standard (or other commodity standard), each central bank pegs the value
of its currency in terms of gold (or other commodities). An ounce of gold
might, for example, be set at S20 in new york and £4 in london (roughly the
values prevailing in 1914). In this environment, the nominal exchange rate
between U.K pounds and U.S dollars had to be close to 0,2 pounds per dollar.
Otherwise (subject to the costs of shipping gold), it would be profitable to
buy gold in one country and sell it in the other. As with bretton woods system,
the classical gold standard would-if adhered to by the participants-maintain
fixed nominal exchange rates among the various currencies.
It
is possible for countries to maintain fixed nominal exchange rate a regime that
has no role for gold or other commodities. For example, from 1079 to 1992,
several western european countries kept the nominal exchange rates among their
currencies fixed within fairly narrow bands. This arrangement, called the
european monetary system (EMS), effectively evolved into the euro, which became
the common currency of 12 western european countries over a transition period
from 1999 to 2001. Although most countries western europe use the euro, some
important are the united kingdom, sweden,denmark, and switzerland.
