Floating Exchange Rates in an Interdependent World: No Simple Solutions to the Problems

In response to a congressional request, GAO examined the role of government policy in determining exchange rates and the role of floating exchange rates in an interdependent world economy. The analysis was focused on: (1) the process of exchange rate determination, particularly the yen-dollar rate and the role of Japanese Government actions; (2) the constraints that international economic interdependence impose on economic policy; and (3) alternatives to the floating exchange rate system. According to some analysts, the floating exchange rate system is not an adequate method to facilitate the growth of world trade and investment. Some governments, especially Japan, are alleged to exert improper influence over exchange rates, while the United States does not exert enough influence. While appreciation of the dollar from 1980 to 1983 lowered the inflation rate, it also reduced the gross national product and caused the loss of over a million jobs. GAO found no support for charges that the Japanese Government pursued a policy to deliberately undervalue the yen relative to the dollar. Any intervention undertaken by that government was aimed at strengthening rather than weakening the yen. However, Japan could do more to facilitate greater international use of the yen. GAO found that exchange rates are affected by the international balance of trade, capital flows among nations, differences between countries' national economic policies and economic conditions, and perceived political risks and expectations. The complications of interdependence and the limits to current understanding of exchange rate behavior have prevented a consensus on the advisability of changing the current system. However, the interdependence of national economies constrain the range of domestic economic policies that the United States can adopt.

GAO sponsored a symposium of specialists on exchange rate behavior. The seminar participants addressed the yen-dollar exchange rates and analyzed the implications of floating exchange rates and economic interdependence on the conduct of national macroeconomic policy and the future of the international financial system. GAO found that it is questionable whether some policy to manage exchange rates can mitigate or reverse the adverse economic effects of exchange rate behavior. One analyst noted that there are alternative definitions of exchange rate overvaluation and several plausible sources of overvaluation. The limits to research in exchange rate behavior partially explain the disagreement over exchange rate management policy, and forecasting long-range exchange rates has not been successful. Although the symposium participants agreed that floating exchange rates cannot insulate an open economy from external economic disturbances or contain domestic disturbances within a single economy, they agreed that flexible exchange rates are superior to fixed rates. Panelists also agreed that policies aimed at countering misaligned exchange rates will have limited success if national macroeconomic policies differ markedly. Furthermore, a policy that addresses only the exchange rate, without addressing monetary and fiscal policies, can have only limited success.

Analyzes developments in the international monetary system since 1973, with anew added epilogue.