Example research essay topic: Exchange Rates Monetary Union - 1,302 words

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... or that crisis passes over (Germany's reunification, for example), we will have economic and political peace and be able to fix exchange rates. But crises in Europe and elsewhere haven't ceased just because Hitler is no longer alive and the Berlin Wall has fallen. Overwhelming problems will at some point strike the system -- we haven't advanced beyond war, mayhem and natural disasters -- and there will be no solution but to leave the monetary regime, as has happened before (notably in World War II).

People with money in the currency market know this, and knowing this, help to make it inevitable. One misconception about fixed exchange rates ought to be noted here: the difference between real and nominal values of money. With fixed rates, nominal exchange rates may be stable but real exchange rates vary. Prices of imports and exports still change relative to each other; this is how the system balances itself. As a country's money supply contracts and expands by the actions of foreigners, the price level within the country changes. (Theoretically, it would go both up and down, but the tendency of prices to "stick" high hinders the balancing mechanism by making deflation rare. ) As one author put it, the attractiveness of fixed rates depends partially on the answer to the question, "How stupid is your labor force?" ("Currency Reform" 21). And how stupid are all the business people?

Is not the fluctuation in the nominal and real values of the currency under a floating system similar to the fluctuation in the real value of fixed currency? The changes in floating exchange rates have proved to be much more volatile than the (real) changes in fixed rates, but it ought to be noted that real values still change under both systems, in both cases to remedy balance of payments problems. Since we would have to sacrifice in order to maintain nominal stability through fixed rates, we ought to remember to ask exactly how much real stability we would be getting in return. The third major proposal for a monetary system is that of monetary unification. This poses some of the same problems as a fixed or targeted rate system. Most people do not support it because, essentially, it unifies too much.

It takes too much power out of the hands of nations and puts it somewhere else. It would, like a free market, increase harmonization (competition) in taxation, another trend that threatens the autonomy of nations (Hornblower 41). Governments would, as in the other two systems, give up a great deal of control over their domestic economies and the problems of individual country's business cycles would be ignored and unregulated. Even if monetary unification was wanted -- and it would remove the problems currency volatility poses for international trade -- its institution would be virtually impossible in the current political climate. "Jealousies, allegiances, the bases of political support remain firmly national; that fact cannot be wished away by a coin" ("Currency Reform" 22). The governments of countries and their populations are further from integration than the economies themselves; it would be impossible to achieve the amount of political coordination -- one could even call it union -- that would be necessary to create and sustain complete monetary unification.

So, what is the answer? Obviously, currency volatility is a problem. Unfortunately, all other alternatives seem worse. There are, at least, some advantages to freely floating rates aside from their existence as the only viable system. First, they can act as "shock absorbers" and moderate the exportation of one country's problems (inflation, for example) to its neighbors ("Fixed and Floating Voters" 64; Friedman, " Introduction " xxiii).

Second, the free market punishes incompetent governments for bad fiscal policies. Mexico's monetary policy was woefully irresponsible; thus, it's hardly a surprise its entire economy collapsed. Competition in the currency market, as in all other things, drives people and governments to be responsible (Becker 34). The system is also in some ways fair.

As Paul Magnusson posts it "arguably reflects the fair value of nations' legal tender based on the fundamentals of growth, inflation, and interest rates. " He goes on to add that "currency volatility is the price of a free market, not a condition to be cured" (108). Just as, for example, it's widely believed that price and rent controls hurt more than they help, so too do government interventions in the currency market. As mentioned above, many even blame government intervention for volatility in the first place, as in the case of the Plaza and Louvre agreements. Some people also argue that volatility may be temporary until the system settles down (Friedman, " Introduction " xxiii).

But this bears some of the marks of the unrealistic optimism of people who seem to believe Europe and the world will be (after we resolve just one more crisis) forever peaceful and ready for unification. The biggest advantage of floating exchange rates is that they give each country control over its domestic affairs. Presumably, it knows best how to handle them, and it is to be hoped that knowledge of the workings of the free market will keep it from doing so irresponsibly. Speculation can be a stabilizing force that demands responsible fiscal policy and money management. The cost of economic stability and prosperity may in fact be exchange rate instability. $ 6. 5 billion to $ 39 billion was estimated to have been spent on hedging in 1989 (Becker 34). But how much money would be lost each year by sacrificing individual economies to the international "good" (as in the case of the European nations that fell into recession during the ERM crisis)?

Besides, as the president of the New York Federal Reserve Bank said, "low inflation is the best assurance of exchange rate stability" (Lewis A 24). Theoretically, intelligent domestic control of national economies will dampen currency volatility as well as improving the health of the economy itself. For all these reasons, floating exchange rates are the best system available to central banks at this time. The mechanism is certainly not without flaws, but it is the only truly feasible choice Governments will always desert a fixed or targeted rate system, either when their reserves run out or when domestic inflation or recession becomes too severe. T he real values of currencies do fluctuate -- that is the problem. Sooner or later a gross imbalance will arise and it will be fixed either by the nation voluntarily leaving the system or by speculators foreseeing its demise and forcing it out.

The solution to that problem, monetary union -- fixed rates with no devaluation or "leaving the system" allowed -- would be impossible to institute and maintain even if it were economically advantageous to all involved. The only realistic and economically sound solution, problematic though it may be, is to have exchange rates float freely and without restriction. Becker, Gary S. "Forget Monetary Union -- Let Europe's Currencies Compete. " Business Week 13 "Currency Reform: A Brief History of Funny Money. " The Economist 6 January 1990: 21 - 24. Eichengreen, Barry and Charles Wyplosz. "Mending Europe's Currency System. " The Economist 5 June 1993: 89. "Fixed and Floating Voters. " The Economist 1 April 1995: 64. Friedman, Milton. "Free-Floating Anxiety. " National Review 12 September 1994: 32 - 36. , " Introduction. " The Merits Of Flexible Exchange Rates. Ed.

Leo Melamed. Fairfax, Virginia: George Mason University Press, 1988. xix-xxv. Hornblower, Margot. "No One Ever Said It Would Be Easy. " Time 1 March 1993: 32 +. "Interview with Alan S. Blinder. " The Region December 1994. Online.

Kimberly. Lewis, Flora, et al. "Is Monetary Union a German Racket?" New Perspectives Quarterly Winter Magnusson, Paul. "The IMF Should Look Forward, Not Back. " Business Week 3 October 1994: Bibliography:

Research essay sample on Exchange Rates Monetary Union