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Global Monetary Policy History and the Evolution of Exchange Rates

By Frances Coppola

Today's international businesses grapple with a complex and volatile foreign exchange environment, as currency exchange rates constantly vary in response to sometimes tiny changes in global economic conditions. But it was not always so.

In this 11-part historical journey, financial journalist Frances Coppola, regularly featured in the Financial Times, The Economist, Forbes, and a range of other financial industry publications, chronicles the evolution of the world's major central banks and relevant foreign exchange policy – and how today's businesses have adapted to hedge foreign exchange risk.

 

Part 1: The Rise and Fall of the Bretton Woods Fixed Exchange Rate System

 

Today's international exchange rates vary with global economic conditions. Post World War II, the Bretton Woods system fixed exchange rates, but it was short-lived. It took much longer for the world's major monetary authorities to transition to today's floating exchange rate and inflation targeting system. Read Article…

 

Part 2: From Fixed Exchange Rates to Inflation Targeting

 

Although exchange rate volatility increases risk, modern monetary policy stabilizes inflation. This is the story of how inflation was eventually brought under control when interest rates replaced exchange rates as the principal tool of monetary policy. But although it successfully decreased inflation, financial policymakers remained reluctant to rely entirely on interest rate policy. Read Article…

 

Part 3: When Cooperation Fails, So Do Managed Exchange Rate Systems

 

High interest rates finally controlled high inflation after Bretton Woods' failure. But taming inflation was not enough; currency volatility remained high even after inflation and interest rates started to stabilize. During the 1980s, policymakers attempted to introduce new fixed or managed exchange rate systems, all of which failed due to the "trilemma" of international economics. Read Article…

 

Part 4: Explaining the Fed, and Why it Matters for International Businesses and Exchange Rates

 

Nowadays, everyone watches "the Fed." What will the Fed do next? Will it raise interest rates? Will it start selling off its stockpile of U.S. government debt and agency mortgage-backed securities? How will it influence the U.S. dollar exchange rate? To provide context for these questions, this article traces the Fed's history and explains how the Federal Reserve System works, its dual mandate – and how it has supported unprecedented economic expansion and confidence for businesses to use the U.S. dollar in international trade, making the dollar the world's premier reserve and settlement currency. Read Article…

 

Part 5: How the Fed's Monetary Policy Affects Exchange Rates

 

To control inflation and unemployment, the Fed no longer directly manages the dollar's exchange rate with any other currency. But the Fed's monetary policy decisions still affect international exchange rates. This is how it works. Read Article…

 

Part 6: The Bank of England, Hub of the Golden Age's Global Fixed Exchange Rate System

 

International businesses see central banks as economic controllers, managing monetary policy using a range of financial tools to meet defined targets for exchange rates, inflation rates, or unemployment rates. But that has not always been their purpose. The Bank of England (BoE) does such things today, but this second-oldest central bank in the world (after Switzerland's) was originally created to fund a war. Read Article…

 

Part 7: Bank of England, Part Two: The Long Decline of The British Pound's Exchange Rate

 

The BoE's journey from Government banker to independent manager of the U.K. economy has encompassed war, depression and the decline of the largest empire in history. Along the way, the $4.70-per-pound exchange rates of a century ago became history, along with the gold standard that supported them. Read Article…

 

Part 8: European Monetary History: Euro is Born of Fixed Exchange Rate Failures

 

Many countries outside Europe have retained control of monetary policy by floating their currency exchange rates. But for the EU, resolving the "trilemma" meant eliminating national autonomy over monetary policy. The European Central Bank (ECB) now controls policy for the Eurozone countries, and also has a say in national fiscal policies for some members. Read Article…

 

Part 9: What the ECB's "Single Mandate" Means for Exchange Rates

 

The ECB is unique among independent central banks in having a legally binding "single mandate" committed to maintaining price stability above all else. This means controlling inflation rather than managing exchange rates. The single mandate ensures that within the Eurozone, the euro's purchasing power is fixed and stable, eliminating trade barriers. But internationally, the exchange rate floats freely, creating FX risk that businesses may wish to hedge. Read Article…

 

Part 10: How Australia Eventually Ended Its Love Affair with Fixed Exchange Rates

 

For U.S. businesses, managing FX risk has become routine in doing business in Australia. The Australian dollar is highly sensitive to changes in the price of international commodities, especially iron ore. A long transition from fixed to floating exchange rates gave Australian banks and FX providers time to develop FX management approaches that international businesses all over the world can now use to manage FX risk. Read Article…

 

Part 11: How Australia's Monetary Policy Changed Since Moving to Floating Exchange Rates

 

After Australia floated its currency exchange rate, it gradually changed its entire approach to monetary policy. Today, the Reserve Bank of Australia's "triple mandate" makes low inflation, low unemployment and strong economic growth equally important goals for policymakers, ensuring economic stability despite exposure to the vagaries of international markets. Read Article…

 

Frances Coppola - The Author

The Author

Frances Coppola

With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.

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