International monetary arrangements for the 21st century

Abstract

A common approach to managed floating is leaning against the wind.When the exchange rate weakens, the central bank or government intervenes to support it.When it strengthens, they intervene to limit its appreciation.9Several rationales are suggested for this policy.One is that many exchange rate fluctuations are temporary and as such confer unnecessary economic costs.If the nominal rate appreciates currently but will depreciate subsequently, leaning against the wind can reduce the costs associated with that purely temporary fluctuation.It is not clear, however, why currency traders, cognizant of this pattern, would not buy currencies which have weakened (and sell those which had strengthened) in anticipation of future capital gains, thereby damping temporary fluctuations and obviating the need for the authorities to lean against the wind in the first place.10Thus, this argument for intervention rests at bottom on the inefficiency of the market."An alternative view is that, absent intervention, most of the shocks driving exchange rate changes are permanent.Recent statistical work suggesting that exchange rates follow a random walk is consistent with this 9 An example of this policy is Canada in the 1950s, then the only industrial country with a floating rate.In 100 of 123 months from October 1950 through December 1960, the Canadian Exchange Fund Account acquired reserves when the currency was strengthening and expended reserves when it was weakening.Yeager (1966), p.426.