What Should Be Done About Exchange Rates?

One of the pleasures of preparing an essay in Gottfried Haberler's honor comes from rereading some of his past contributions. The two quotations at the start of this essay, although written a generation apart, are as relevant to current discussions of European monetary union and policy coordination as they were to the subjects addressed at the time they were written. The first quotation, criticizing early postwar proponents of a world central bank, reminds us that gains from a common currency—whether for Europe or all the world's open economies—depend on the policy rule adopted by the proposed monetary authority. A policy rule that avoids both inflation and deflation increases welfare; rules, procedures, or discretionary actions that produce price instability do not. This applies equally if the actions are coordinated. Indeed, coordination that produces inflation in all leading countries is clearly worse than uncoordinated policies that leave one or more countries pursuing price stability. The second quotation takes a balanced view of fixed and fluctuating exchange rates. Fixed rates can, in principle, increase welfare. Whether they do so in practice depends on the policies followed by the central banks and governments.