Flexible Exchange Rates, Prices and the Role of ‘News’: Lessons from the 1970s

Abstract

Recent experience with flexible exchange rate systems has led to renewed interest in the operation of foreign exchange markets as reflected in many recent studies of the principal determinants of exchange rates. The 1970s witnessed the dramatic alteration of the international monetary system from a regime of pegged exchange rates which prevailed for about a quarter of a century (since the Bretton Woods conference) into a regime of flexible (though managed) rates. As a consequence of the emergence of the new legal and economic system traders, national governments and international organisations were confronted with new economic problems, choices and instruments. During the 1970s ex-change rates fluctuated widely and inflation rates accelerated. The international monetary system had to accommodate extraordinarily large oil-related shocks which affected trade flows in goods and assets. Huge oil payments had to be recycled. Uncertainties concerning future developments in international politics reached new heights and the prospects for the world economy got gloomier. These developments placed unprecedented pressures on the markets for foreign exchange as well as on other asset markets. They were associated with a large slide in the value of the US dollar, and resulted in speeding up the creation of new institutions like the European monetary system which provided the formal framework for the management of exchange rates among members.KeywordsExchange RateInterest RatePurchase Power ParityPurchase Power ParityForward RateThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.