Issues in the choice of an exchange rate regime

The adoption of a satisfactory exchange rate regime has been one of the most prominent issues which policy makers in Eastern Europe have been facing since the transition process began some five years ago. Such prominence is justified from several viewpoints. The exchange rate has often been identified as a “prestige” variable, with respect to which politicians in all countries tend to be fairly sensitive. In addition, it is often an attractive tool for economic policy; for instance, the imbalances caused by an expansionary monetary policy may be corrected by devaluation.

To simplify matters, one may say that the choice of the appropriate exchange rate regime boils down to the role of convertibility, that is, the freedom to buy currencies, assets, and commodities with given amounts of the domestic currency; of course, the price at which such transactions take place (the nominal exchange rate) may be fixed by the central bank, or flexible, according to supply and demand conditions.

Clearly, free-market principles suggest the adoption of a convertible, flexible exchange rate currency. Yet, a more or less cautious neoclassical macroeconomic approach has usually been preferred instead, so that the choice of the appropriate exchange rate policy and regime is no longer clear-cut.