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Floating Exchange Rates The Only Viable SolutionStentor SmithFor some the collapse of Mexicos economy proves that floating exchangerates and marketswithout capital controls are deadly Others find the crash of the Europeanexchange-rate mechanismERM in 1993 to be proof that targeted rates will always be overturned bythe free market Manysee the breakup of Bretton Woods as the failure of fixed rates Yet othersbelieve monetaryunification in Europe is the only way to achieve economic and politicalstability Many others hold stilldifferent beliefs There are however four main proposals for the managementof internationalcurrency exchange rates monetary unification fixed rates floating ratesmaintained within certainreasonable limits of variability and freely floating rates Both fixedexchange rates and rates basedon either explicit or unwritten targeting are impossible to maintain especiallyin an era of free tradeComplete monetary unification would be impossible to bring about withoutextensive integration andunification of international governments and economies a task so vast thatit is unlikely ever to beaccomplished Thus the only option central banks have is to allow exchangerates to float freelyThe European Monetary System which virtually collapsed in 1993 was an attemptto fix exchangerates within certain tight bands to coordinate monetary policy between membernations and to havecentral banks intervene to keep exchange rates within the bands when necessaryThe reasons for thecollapse were myriad but simply put it happened because Germany dealingwith financial problemsin part arising from its reunification refused to lower its high interestrates This meant other Europeancountries either had to keep their rates equally high and allow themselvesto fall into recession as aresult or devalue their currency against the mark a move viewed by manyas a politicalembarrassment The possibility of a devaluation caused speculators to boltfrom the lira the poundthe franc and other currencies sending the markets into chaos and destroyingall semblance ofstability In the end the ERM was adjusted to allow currencies to fluctuatewithin 15 percent oneither side of their assigned level up from in most cases a limitationof 225 percent The bandsbecame too wide to be meaningful
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