A Reevaluation of Exchange Rate Policy

Abstract

over 18 years have elapsed since the breakdown of the Bretton Woods system without any serious efforts to restore fixed exchange rates among the currencies of the major industrialized countries. The last attempt to reconstruct the exchange rate system, the Smithsonian Agreement of December 1971, broke down almost immediately. Recent economic summits have agreed on ad hoc policies to counter exchange rate movements and have considered modest proposals to modify the existing system, but these summits have made no progress on more systematic changes in exchange rate arrangements. Governments may have refrained from 'reforming' the system for good reasons. This paper considers various reform proposals ranging from a return to fixed exchange rates to more modest proposals such as target zones or co-ordinated foreign exchange intervention.1 When considering possible reforms of the exchange rate system, it is natural to compare experience since 1973 with that of the Bretton Woods period. The decade of the 1960s was a time of much superior economic performance. During the 1960s, inflation was markedly lower in all major industrialized countries, with the notable exception of Japan where inflation in the 1980s has been half of what it was in the 1960s.2 Real growth in gross national product was higher during the 1960s in all countries. Productivity growth was also higher in all countries during the 1960s than during the 1973-1985 period as a whole, although in the United States and Britain productivity growth during the 1980s has exceeded that of the 1960s. Fi-