Final Remarks

Exchange Rate Regimes
in the 21st Century:
Final Remarks
Kazuo Ueda
Bank of Japan

I. Introduction
In my final remarks, I would like to first briefly discuss the proposal that Japanshould weaken the yen substantially to turn around its ailing economy. I will thenproceed to summarizing some of the salient features of the discussion on exchange
rate regimes during the conference.

II. Exchange Rate Policy as a Remedy for a Liquidity Trap
Several participants recommended that Japan should substantially weaken the yen tostimulate the economy. Let me first emphasize that this is clearly an exchange rate
policy, which has been assigned, by law, to the Ministry of Finance (MOF) and not
to the Bank of Japan (BOJ). Having said that, I would like to discuss some possible
macroeconomic consequences of such an action. First, a weaker yen should raise net
exports. But in addition, domestic interest rates would rise, especially if the yen wasfixed at a weaker level. As Maurice Obstfeld pointed out, we would be able to get
out of the liquidity trap as a result. However, higher interest rates would surely
have an adverse effect on borrowers of funds and financial institutions, worsening thebad-loan problem plaguing the economy. It should also be noted that the BOJ would
not regain the flexibility to lower interest rates. Under a fixed exchange rate, Japaneseinterest rates would move in response to the Federal Reserve Board’s monetary policy.
In a different vein, Masahiro Kawai argued that the BOJ should stop sterilizing
foreign exchange market intervention. Sterilized and non-sterilized interventions
are different up to the effects of the BOJ’s purchases of treasury bills (TBs) on theeconomy. The effects of TB purchases, however, would be small under a zero interest
rate. And the BOJ has already been buying TBs and other assets massively to expand
the monetary base at a growth rate close to 30 percent. In addition, those arguing for“non-sterilization” of foreign exchange market intervention seem to miss a technicalpoint about the monetary operation of the BOJ. Typically, the MOF buys foreignexchange by selling, for example, three-month TBs to the BOJ. If left non-sterilized,
the operation increases monetary base for a period of three months. After threemonths, the MOF will have to raise money in the market to pay back the TBs, atwhich point monetary base returns to the previous level. The resulting time path ofmonetary base is very bumpy and does not seem to produce any fruitful results. The275

only remaining possibility would be for the BOJ to create a target on monetary baseor bank reserves, which and what we currently do, and to move it in response tothe MOF’s interventions. Such a policy rule, however, would imply subordinationof monetary policy to exchange rate policy and does not seem to be prudent
behavior on the part of the BOJ.

III. Discussion on Exchange Rate Regimes
During the conference, I have been trying to determine the degree of support forthe bipolar view among the participants. As far as I could see, the support was notas strong as I had expected. But at the same time, the participants addressed thedifficulty of intermediate currency regimes much more carefully than in previous
conferences with similar topics.
The choice of optimal currency regime seems to depend on a number of factors,
and is also not invariant over time. For G-3 countries, many participants supported
the idea that free floats were the optimal regime, although some suggested that Japanuse an exchange rate-based stabilization technique as discussed above. The case forfloating rates among the G-3 economies was most clearly expressed by Obstfeld;
flexibility in exchange rates is useful in replicating, in his language, the flexible priceequilibrium in the presence of nominal price rigidities. Of course, the conclusion
depends greatly on the pricing behavior of companies in response to exchange ratechanges as well as on distortions other than nominal price rigidities. Concerning
the possible costs of excessive volatility of exchange rates, Roger Ferguson pointed
out that such costs were not serious in the G-3 countries, because there were manyfinancial techniques that allowed companies and households to hedge against
exchange rate changes.
For smaller countries, some participants recommended hard pegs and others
spoke for free floats. Arguments against the bipolar view were also made. Aversion to
the bipolar view was strongest among some East Asian participants, including Kawai.
The structure of Asian trade is fairly diversified; the memory of the East Asian crises
is still fresh. Hence, some participants argued for a soft peg to a basket of currencies,
or even argued for a common currency in the region. But it was not clear to me why
a peg to a basket was more durable than a peg to a single currency. In addition, somepointed out the need for political integration to precede currency union.
For Latin America, the demand for using a hard peg to impose monetary and/or
fiscal discipline seemed very high. Some participants, however, viewed the use of apeg for this purpose as only a temporary remedy. It was intended to buy time for
whoever was in charge of economic policy to put their house in order. Some went on
to say that a hard peg would be no longer necessary once appropriate macroeconomic
policy and political institutions were in place.
This line of argument raised the following points. First, of course, the choice of
optimal currency regime depended not only on economic factors but also on politicaland social factors. In fact, some pointed out that we needed to go beyond the domainof narrow-minded economists to analyze these questions more fully. Second, the276 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2002

Final Remarks

optimal currency regime must change in response to changes in institutions. This
point was already illustrated, for example, by the use of a hard peg for inflation
stabilization, but possibly for a temporary period. Additionally, the temporal natureof some currency regimes raised the difficult question of how to formulate an exit
strategy from them.
In conclusion, people seem to have agreed that we need to analyze more carefully
and in dynamic contexts implications of various existing distortions, including
political and social factors, for the choice of the optimal currency regime. Hopefully,
the new international macroeconomics will offer a nice playground here.

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