In the past three months, several of Southeast Asia's most important currencies have come unstuck from their links to the U.S. dollar. In fact, either fixing or floating can succeed, as shown by Hong Kong's fixed rate and New Zealand's float. What matters is that once a country makes the choice, it must then follow consistent policies. Each of these managed pegs could have operated indefinitely, had each country's leaders arrived at a coherent strategy and stuck to it. But to use both tools together sends distorted signals to the market.
Sound policy comes when a central bank chooses one tool and resolutely refuses to use the other.
For example, the only sure way to achieve a foreign-exchange rate target is for the central bank to stay out of the domestic money market. Only then will interest rates, bond yields, monetary conditions, the level and composition of total spending, and the price level be consistent with the targeted exchange rate. Conversely, if a central bank chooses to float, it must then set an intermediate operating target, such as a particular measure of the money supply or of domestic credit, and an ultimate target, such as the price level or nominal gross national product. Put another way, a float means letting the exchange rate adjust to foreign or domestic influences, including changes in the domestic money and credit market. Only then will the chosen intermediate target ensure a stable price level.