Reining in Exchange Rates: A Better Way to Stabilize the Global Economy

Publication Date: September 2002

Publisher: Economic Policy Institute

Author(s): Christian E. Weller; Laura Singleton

Research Area: Banking and finance; Economics

Type: Brief

Abstract:

The rise and limited fall of the dollar reflects a failure of foreign currency markets to properly manage exchange rates because flexible exchange rates are prone to over- and undervaluations. Although governments can and do intervene to influence exchange rates, their resources are limited compared to the size of currency markets. And the interests of many countries are not necessarily aligned, such that the intervention by one country may very well be opposed, or at least not supported by, other countries.

The stability of the global economy, however, is in everybody's interest. To avoid exposing industrialized economies and many emerging economies to rapid, large, and uncontrolled currency fluctuations, a new, more regulated exchange rate regime is needed. This change requires a system of exchange rates whereby participating central banks coordinate their efforts to intervene in order to maintain exchange rate stability, coupled with capital controls to reduce the influence of large financial flows in currency markets.