[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

TRADE-WEIGHTED EXCHANGE RATE (MARCH 1973 = 100)
140
130
120
110
100
90
80
70
60
Real
Nominal
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Figure 34.6
VOLATILITY OF NOMINAL AND
REAL EXCHANGE RATES
Both the nominal and real exchange rates for the United States fluctuated considerably
over the 1980s. The figure shows the trade-weighted value of the dollar relative to other
currencies, unadjusted (nominal) and adjusted (real) for price-level changes in the United
States and abroad.
SOURCE: Economic Report of the President (2004).
For example, if the dollar seems to be climbing too high against the yen, a plan might
propose that the Fed sell dollars and buy yen, thereby pushing up the demand for
yen and increasing the supply of dollars. Producers in the United States may be
delighted by this move; demand for exports will increase, as will demand for goods that
compete closely with imports. But producers in Japan will have just the opposite
reaction. If the Japanese government, responding to these pressures, were to intervene
simultaneously and start selling yen and buying dollars, the two efforts would
offset each other. In effect, it would be as if the U.S. government sold dollars in exchange
for yen directly to the Japanese government, with private markets unaffected.
This brings up a third requirement of exchange rate stabilization proposals:
there must be some degree of cooperation among countries. This is particularly true in
the modern world economy, where no single country is dominant. There are several
big players—Japan, the Economic and Monetary Union, and the United States—
and setting exchange rates requires these governments to work together.
Case in Point
CURRENCY BOARDS AND DOLLARIZATION
Currency crises in Latin America and Asia have increased interest in new forms of
monetary reform that could avoid future crises. Two suggestions that have figured
prominently in discussions are a currency board and dollarization.
772 ∂ CHAPTER 34 THE INTERNATIONAL FINANCIAL SYSTEM