Part 2 book “Economics for financial markets” has contents: Bubbleology and financial markets, the new economic paradigm - how does it affect the valuation of financial markets, the global foreign exchange rate system and the ‘euroization’ of the currency markets, and other contents. | 8 The global foreign exchange rate system and the ‘Euroization’ of the currency markets† What is the ideal exchange rate system that a country should adopt? The economics literature has identified a number of factors relating to an economy’s structural characteristics, its susceptibility to external shocks, and macroeconomic and institutional conditions that influence the relative desirability of alternative exchange rate regimes. The early literature on the choice of exchange rate regime, which was based on the theory of optimum currency areas, focused on the characteristics that determine whether a country would be better off, in terms of its ability to maintain internal and external balance, with a fixed or a flexible exchange rate arrangement. That literature generally indicated that small open economies, meaning economies where trade represents a large proportion of GNP, are better served by a fixed exchange rate. The less diversified a country’s production and export structure is and the more geographically concentrated its trade, the stronger also is the case for a fixed exchange rate. The attractiveness of a † The contents of this chapter are discussed in more detail in Kettell, B. (2000) What Drives Currency Markets? Financial Times–Prentice Hall. The global foreign exchange rate system and the ‘Euroization’ of the currency markets 175 fixed exchange rate is also greater, the higher the degree of factor mobility is, the less a country’s inflation rate diverges from that of its main trading partners, and the lower the level of economic and financial development is (see Table ). Another approach to the choice of exchange rate regime has focused on the effects of various random disturbances on the domestic economy. The optimal regime in this framework is the one that stabilizes macroeconomic performance, that is, minimizes fluctuations in output, real consumption, the domestic price level, or some other macroeconomic variable. The ranking of fixed and
