Frankel challenges current consensus on need for pure fixed or floating exchange rate regimes

• Author: Lynn Aylward
• Position: IMF External Relations Department
• Pages: 273-275

Page 273

Jeffrey Frankel came to Washington to enlist IMF economists in his search for the “missing middle”— the wide center ground that fills the spectrum between the extremes of fixed and floating exchange rates. In a lively presentation at an IMF Institute seminar on August 7, Frankel reviewed current issues in research and policy on exchange rate regimes but chiefly focused on a conundrum. Why is it that while it is the post-Asian crisis fashion for economists and policymakers to advocate deserting intermediate exchange rate regimes, roughly half of all countries still inhabit this middle ground?

In an effort to unravel the mystery of the missing middle, the Harpel Chair professor of Harvard University’s School of Government explored whether exchange rate regimes matter for the real economy, weighed the respective advantages of fixed versus floating rates, and examined new criteria for optimum currency areas.

Ultimately, Frankel argued, the real culprit is not intermediate exchange rate regimes but the notion that any single currency regime is right for all countries at all times.

Frankel: No single currency regime is right for all countries at all times.

Exchange rate goals

Drawing on the Princeton University Graham Lecture that he presented in April this year, Frankel noted that in the late 1990s, a view evolved that only a rigidly fixed exchange rate or a clean float would solve the problems that come with modern globalized financial markets. This hypothesis, Frankel observed, seems to be held as a corollary of the “impossible trinity,” which posits that a country can pick only two goals from the tripartite menu of exchange rate stability,Page 275 monetary independence, and financial market integration.

Frankel provided a new angle on the trinity, noting that, as international financial market integration becomes more of a given, countries’ options seem to boil down to a single choice: exchange rate stability or monetary independence. But while a country cannot have complete exchange rate stability and complete monetary policy independence, it could—through a managed float—have some of both.

Frankel did not overlook the motivations that might prompt a country to abandon the “soft middle ground of flexible rates.” Monetary union and pure floating are the two regimes invulnerable to speculative attack, and complicated intermediate regimes may be insufficiently transparent to...