Exchange Rate Regimes, Globalization, Financial Crises, and Monetary Policy

My research in the past decade has concentrated largely on four related themes that I discuss in this article: Exchange Rate Regimes, Globalization, Financial Crises, and Monetary Policy. Exchange Rate Regimes As discussed in the Fall 1999 NBER Reporter, much of my earlier work focused on the gold standard and related monetary regimes. A series of papers with Finn Kydland, Ronald MacDonald, and Hugh Rockoff emphasized the importance of credible commitment mechanisms in the design of monetary regimes, focusing on the gold standard. (1) My recent work extends this approach. The choice of exchange rate regimes, between fixed and floating exchange rates, evolved considerably in the past hundred years. (2) Before 1914, advanced countries adhered to gold while periphery countries either emulated the advanced countries or floated. Some peripheral countries were especially vulnerable to financial crises and debt default, in large part because of their extensive external debt obligations denominated in core country currencies. This left them with the difficult choice of floating but restricting external borrowing or devoting considerable resources to maintaining an extra hard peg. Today while advanced countries can successfully float, emergers who are less financially mature and must borrow abroad in advanced country currencies are afraid to float, for the same reason as their nineteenth century forbearers were. To obtain access to foreign capital, they may need a hard peg to the core country currencies. In my paper with Marc Flandreau the key distinction between core and periphery countries, both then and now, is financial maturity, evidenced in the ability to issue international securities denominated in domestic currency (3) (or the absence of sin, a phrase coined by Eichengreen and Haussman (1999) (4)). However, a case study by Chris Meissner, Angela Redish, and myself of the debt history of several former colonies of Great Britain (the United States, Canada, Australia, New Zealand, and South Africa), who had largely overcome the problem of original sin by the third quarter of the twentieth century, finds that sound fiscal institutions, high credibility of the monetary regimes, and good financial development are not sufficient to completely break free from original sin. Conversely, poor performance in these policy realms is not, for the most part, a necessary condition for Original Sin. The factor we emphasize for the common progress toward borrowing in domestic currencies across the five countries is the presence of shocks, such as wars, massive economic disruption, and the emergence of global markets. The differences in evolution between the United States and the Dominions we attribute to differences in size, the role of a key currency, which characterized the United States and not the others, and to membership in the British Empire. The importance of major shocks suggests that the establishment of a domestic bond market that mitigated these effects involved significant start-up costs, while the importance of scale suggests that network externalities and liquidity were pivotal in the emergence of overseas markets in domestic currency debt. (5) The limiting case of a fixed exchange rate regime is a monetary union. My study of the history of monetary unions (MUs) with Lars Jonung (6)--based on the examples of the United States, Germany, and Italy--suggests that the success of MUs of the past has been intimately linked with both fiscal and political unification. The implementation of EMU was largely driven by the political will of elites and its ultimate success may also depend upon the political will of the citizenship. Globalization Globalization--the integration of goods, labor, and capital markets--has been one of the dominant issues in the past several decades. The present era of globalization was preceded by an earlier era in the late nineteenth century--from 1870 to World War I. …

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