Economics and Finance


A Note on Exchange Rate Management and Gravity Equation: Developing Country's Viewpoint

Authors: V. Christianto, Florentin Smarandache

In the last few decades, the flexible exchange rate has become the predominating policy implemented by most countries in the World, except only a few countries who can keep their exchange rates fixed. The predominating position can be attributed mainly to Milton Friedman's strong support. What is less known, nonetheless, is a hidden premise that the flexible exchange rate policy will help fiscal policy in the sense that only governments who do not manage the fiscal policy properly will get 'punished' by exchange rate decreases. But as the US-Japan experience showed [1], this widely-held assumption is often not realistic. The same experience has been observed in other countries too, i.e. that financial liberalization including flexible exchange rate often became precursor of financial instability [2]. While in the past year, in Indonesia for particular, the exchange rate remains stable, it does not mean that it would be free from troubles in the future. Therefore it is worthwhile to explore some other choices for better exchange rate policy. In the present paper will discuss, albeit in somewhat 'crude' manner, some long-term approaches which have been discussed in the literature, and also not-so conventional approaches which may be suitable for short term purposes. The basic proposition in the present paper is that we argue in favor of returning to fixed (or pegging) exchange rate, but of course it is not realistic to promote this policy for the short-term future. Therefore we explore some unconventional alternatives for short-term. It is our hope that the proposition would be useful to explore further by the economics policy makers.

Comments: 6 pages

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Submission history

[v1] 8 Mar 2010

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