MONETARY INDEPENDENCE UNDER FLOATING EXCHANGE RATES

Abstract

THE PERIOD SINCE February 1973 provides the first opportunity since the 1920's to evaluate substantial experiences with floating exchange rate system. With the exception of Canada in the 1950's, the prior experience with floating rates has been limited to the brief interludes, largely interim floating toward new parities. Since the period is transitional from a pegged system to a floating system, the evidence may not be typical for a longer period. The movements in the exchange rates of several countries within the last twenty months have been sharp. Several currencies have appreciated by as much as 20 or 30 per cent within a few weeks; several have depreciated by as much as 10 and 15 per cent within a week. Onesource of stress had been the October 1973 oil embargo and its anticipated impacts on trade balances of various countries. However, much of the sharp movement in the exchange rates occurred before the embargo. The contrast in the behavior of the spot rates for five major currencies relative to the dollar is evident in Table 1, both in terms of the percentage changes in the closing spot rate from one week to the next, and the spreads in percentage terms, between the maximum high and the minimum low rates for each week. The frequency of large changes is substantially higher in the mark and the Swiss franc than in the yen and the Canadian dollar. The appreciation of the mark until July, 1973 and its subsequent depreciation reflected variations in German monetary policy. Because the major advantage attributed to a floating rate system is the increased scope for national monetary independence, the impact of changes in monetary policy on the exchange rate and on prices and employment is a critical issue in the appraisal of the advantages attributed to a floating rate system.1 Central bank intervention under the floating rate system complicates the evaluation of the system's alleged advantages. Numerous European countries participated in the joint float. The variations in the foreign exchange value of the mark appeared to induce similar variations in other European currencies, so that a de facto mark currency area developed. The movements in the Swiss franc, which was not in the snake-in-thetunnel arrangement, parallel those of the mark.