The current exchange rate regime, subscribed to by the leading industrial countries, is one of quasi-flexible exchange rates and has existed since 1973. The present regime did not come into being as a result of a careful consideration of the supposed advantages of flexible rates, but rather as a result of dissatisfaction with the previous Bretton Woods regime of fixed but adjustable exchange rates, which, in turn, was a reaction to the experience of flexible exchange rates in the inter-war period. No sooner had the present regime been inaugurated than there was widespread discussion of the problems with the regime, particularly the relatively high volatility of exchange rates, and proposals for alternative regimes, based on greater fixity of exchange rates, have been widely canvassed. The evolution of exchange rate regimes would appear to be a classic example of history repeating itself.

The problems facing governments are first, how to set an exchange rate regime, and second, how to determine exchange rates themselves. The standard base-line view of exchange rate determination is purchasing power parity (PPP), which asserts that exchange rate is determined by the ratio of a domestic price level to an equivalent foreign price level. An alternative is the balance of payments approach, which asserts that the exchange rate moves to ensure the sum of the current and capital accounts of the balance of payments is zero. More recently attention has focused on the asset market model, whivh interprets the exchange rate as the relative price of two assets (monies), instead of traded goods or balance of payments.

Recent experience with flexible exchange rates has been unsatisfactory because of the excessive volatility exchange rates exhibit when they are market determined. There is now some pressure towards a return to more fixed exchange rate structures. However, the success of these structures may well depend on which of the three methods above will be used to fix exchange rates.

Ronald MacDonald