Exchange Rates Regimes: Fix or Float?

New Media  | 02 de enero de 2018  | Vistas: 1186

Lawrence White talks about the difference between a fixed exchange rate regime and a float one and what implications each one has. Also, he explains the Purchasing Power Parity (PPP) theory, which relate exchange rates with inflation.

While a fixed exchange rate regime sets a monetary policy rule to keep the local money at a fixed rate in a trustworthy money; a float regime removes that rule. The PPP theory explains that floating currencies are valued according to what they will buy.

Exchange rate movements follow inflation differentials fairly closely. The PPP implies that the country with higher inflation will have a depreciating currency. With a fixed exchange rate between two regions, the adjustment to bring PPP about is interregional money flows rather than exchange rates changes.

Money will go away where its purchasing power is higher until it equalizes”

With a fixed exchange, it is possible to avoid:

• High and unstable inflation rates
• Associated financial-market weakness
• Unstable exchange rates

Money flows are reflecting disequilibrium between prices levels in two countries and they’re correcting the disequilibrium”.

Among Latin American countries, floating regimes have shown:

• Higher real interest rates
• Shallower financial markets
• Weaker capital formation and economic growth

All due to the greater risk of depreciation facing investors.

White finishes talking about dollarization, a hard type of fixed exchange rate, that some countries had adopted to reduce the risks of floating regimes.