WORKING PAPER 08-3

Exchange Rate Economics

by John Williamson, Peterson Institute for International Economics

The paper summarizes the current theory of how a floating exchange rate is determined, dividing the subject into what determines the steady state and what determines the transition to steady state. The inadequacies of this model are examined, and an alternative "behavioral" model, which recognizes that the foreign exchange market is populated by both fundamentalists and chartists is presented. It is argued that the main importance of understanding the foreign exchange market for development strategy is to permit a correct appraisal of the dangers of Dutch disease. Empirically it seems that from the standpoint of promoting development it is preferable to have a mildly undervalued rate. The paper concludes by examining implications for exchange rate regimes.

View full document [pdf]

RELATED LINKS

Policy Brief 09-10: 2009 Estimates of Fundamental Equilibrium Exchange Rates June 2009

Book: Future of China's Exchange Rate Policy, The July 2009

Book: Debating China's Exchange Rate Policy April 2008

Article: The Dollar and the Deficits: How Washington Can Prevent the Next Crisis November 2009

Policy Brief 09-21: The Future of the Dollar September 2009

Policy Brief 09-20: Why SDRs Could Rival the Dollar September 2009

Book: Accountability and Oversight of US Exchange Rate Policy June 2008

Book: China's Rise: Challenges and Opportunities (hardcover) September 2008

Op-ed: China's Currency Needs to Rise Further July 22, 2008

Speech: Is China a Currency “Manipulator”? January 28, 2009

Working Paper 08-2: Currency Undervaluation and Sovereign Wealth Funds: A New Role for the World Trade Organization January 2008

Policy Brief 07-8: The Case for Exchange Rate Flexibility in Oil-Exporting Economies November 2007

Testimony: The Dollar and the Renminbi May 23, 2007

Testimony: The Chinese Exchange Rate and the US Economy January 31, 2007

Policy Brief 07-4: Global Imbalances: Time for Action March 2007

Op-ed: When the Dollar Bill Comes Due April 27, 2005

Policy Brief 05-1: A Currency Basket for East Asia, Not Just China August 2005

Working Paper 04-1: Adjusting China's Exchange Rate Policies June 2004

Book: Inflation Targeting in the World Economy October 2003