What you will learn
in this Module:
- The meaning and purpose of
devaluation and revaluation
of a currency under a fixed
exchange rate regime - Why open -economy
considerations affect
macroeconomic policy under
floating exchange rates
module 44 Exchange Rates and Macroeconomic Policy 437
Module 44
Exchange Rates and
Macroeconomic Policy
Exchange Rates and Macroeconomic Policy
When the euro was created in 1999, there were celebrations across the nations of
Europe—with a few notable exceptions. You see, some countries chose not to adopt
the new currency. The most important of these was Britain, but other European coun-
tries, such as Switzerland and Sweden, also decided that the euro was not for them.
Why did Britain say no? Part of the answer was national pride: for example,
if Britain gave up the pound, it would also have to give up currency that bears
the portrait of the queen. But there were also serious economic concerns about giv-
ing up the pound in favor of the euro. British economists who favored adoption of
the euro argued that if Britain used the same currency as its neighbors, the coun-
try’s international trade would expand and its economy would become more pro-
ductive. But other economists pointed out that adopting the euro would take away
Britain’s ability to have an independent monetary policy and might lead to macro-
economic problems.
As this discussion suggests, the fact that modern economies are open to interna-
tional trade and capital flows adds a new level of complication to our analysis of
macroeconomic policy. Let’s look at three policy issues raised by open -economy
macroeconomics.
Devaluation and Revaluation of Fixed Exchange Rates
Historically, fixed exchange rates haven’t been permanent commitments. Sometimes
countries with a fixed exchange rate switch to a floating rate. In other cases, they re-
tain a fixed exchange rate regime but change the target exchange rate. Such adjust-
ments in the target were common during the Bretton Woods era. For example, in 1967
Britain changed the exchange rate of the pound against the U.S. dollar from US$2.80
per £1 to US$2.40 per £1. A modern example is Argentina, which maintained a fixed
exchange rate against the dollar from 1991 to 2001, but switched to a floating ex-
change rate at the end of 2001.