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International Trade and Finance

Notes countries for exchange rate stability. According to McKinnon, the US, Germany and Japan should
have the optimal degree of exchange rate stability by fixing the exchange rates among their
currencies at the equilibrium level based on the purchasing power parity. Thus they would co-
ordinate their monetary policies for exchange rate stability.
2. Establishing Target Zones : Williamson called for the establishment of target zones within
which fluctuations in exchange rates of major currencies may be permitted. According to him,
the forces of demand and supply should determine the equilibrium exchange rate. There should
be an upper target zone of 10% above the equilibrium rate and a lower target zone of 10% below
the equilibrium exchange rate. The exchange rate should not be allowed to move outside the
two target zones by official intervention. In February 1987, the leading five developed countries
agreed under the Louvre Agreement to have some sort of target zones for the stability of exchange
rates among their currencies. Despite official intervention by these countries, the exchange rates
continued to fluctuate within wide margins than agreed upon at Louvre. Thus Williamson’s
proposal has since been discarded being impracticable.
3. Improving Global Liquidity : The reform package of the present world monetary system should
improve global liquidity. As a first step, both BOP deficit and surplus countries should take
steps to reduce a persistent imbalance through exchange rate changes via internal policy
measures. Second, they should also cooperate in curbing large flows of “hot money” that
destabilise their currencies. Third, they should be willing to settle their BOP imbalances through
SDRs rather than through gold or dollar as reserve assets. Fourth, there should be increasing
flow of resources to the developing countries.
4. Leaning Against the Wind : To reduce the fluctuations in exchange rates, the IMF Guidelines for
the Management of Floating Exchange Rates, 1974 suggested the idea of leaning against the wind.
It means that the central banks should intervene to reduce short-term fluctuations in exchange
rates but leave the long-term fluctuations to be adjusted by the market forces.
5. Richard Cooper suggests a global central bank with a global currency which should be a global
lender of last resort.
6. Jaffrey Sachs proposes the creation of an international bankruptcy court which should deal
with countries.
7. George Soros opines that the IMF should set ceilings for external finance for each country beyond
which access to private capital need not be insured. But there should be mandatory insurance
by an international credit insurance corporation.
8. Paul Krugman suggests reintroduction of capital controls as a “least bad response” to an
international crisis.
9. Objective Indicators : To iron out exchange rate fluctuations, the IMF Interim Committee
suggested the adoption of such objective indicators as inflation-unemployment, growth of money
supply, growth of GNP, fiscal balance, balance of trade and international reserves. The variations
in these indicators require the adoption of restrictive monetary-fiscal measures to bring stability
in exchange rates.
Self-Assessment

1. Choose the correct options:
(i) Which of the following could result from a current account surplus that is too large?
(a) Capital flight
(b) Excessive investment expenditure.
(c) Excessive consumption expenditure.
(d) Difficulties for domestic creditors in collecting their money.
(e) Excessive foreign debt.

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