Handbook of Exchange Rates

5.4 Trends in Currency Use

The currency crises of the EMS, Latin America, and Asia highlighted the fragility of adjustable peg regimes in the context of liberalized capital accounts. This led some to argue that, in fact, only two polar exchange rate regimes were sustainable—namely, a pure float and a hard fix, such as a currency board or a monetary union (Eichengreen, 1994; Obstfeld and Rogoff, 1995). All the intermediate cases of exchange rate regimes, including adjustable pegs and managed floats, were viewed as ultimately condemned to disappear. To quote Eichengreen (1994, pp. 4–5), “… contingent policy rules to hit explicit exchange rate targets will no longer be viable in the twenty-first century … [C]ountries will be forced to choose between floating exchange rates on the one hand and monetary unification on the other.” This theory was called the “two poles” or “hollowing out” hypothesis. It was supported by the well-accepted proposition that countries had to choose at most two among the following three policy objectives, which taken together, were inconsistent: (i) monetary independence; (ii) a pegged exchange rate; and (iii) capital mobility.

Others objected that countries could still choose to trade off one of the policy objectives for the other two and that, moreover, the choice was not all or nothing (Frankel, 1999). For instance, some limits on capital mobility might afford a country some monetary independence even with a pegged exchange rate. Moreover, countries could ...