Today’s Monetary Choices

Following the Asian financial crises and its global repercussions, which included the collapse of fixed exchange rates in Russia and Brazil, debate has raged about how to secure macroeconomic stability. The alternatives have seemingly boiled down to a choice between systems in which the exchange rate is rigorously fixed and serves as an anchor and those where the exchange rate is allowed to float freely with the central bank targeting a low level of inflation and then doing all it can to hit that target.

Fixed exchange rates were popular in the hard fight against inflation that marked the last two decades in many emerging markets, especially in Latin America. These anchors succeeded in taming inflation and even in

smothering hyper-inflation. With inflation's fall, however, policymakers sought greater discretion in managing their exchange rates and moved toward intermediate systems, including fixed but adjustable rates, exchange rate bands, crawling pegs, and pre-announced rates. That trend was setback by the financial panics of three years ago and exchange rate regimes previously seen as extreme policy choices acquired new prominence.

Governments, it seems, now prefer to either find institutional mechanisms that guarantee a fixed exchange rate or adopt a free floating system where they refuse to intervene in foreign exchange markets to defend the currency. That first option – i.e., a strengthened fixed exchange rate, is manifest today in Argentina's currency board, in the establishment of a common currency (as in Europe with its Euro), and the abandonment of national currencies in favor of the dollar, policies adopted by Panama and, recently, by Ecuador.