Preliminary

During the birth and infancy of the Bretton Woods system, the debate on exchange rate regimes was dominated by systemic arguments and concerns. The fathers of Bretton Woods believed that a centrally supervised system of fixed exchange rates was key to postwar prosperity, as it would shield international trade both from exchange rate volatility and from exchange rate manipulation by individual countries. Against this view, a classic 1953 article by Milton Friedman argued that exchange rate volatility was a symptom rather than a cause of economic imbalances. Fixing the exchange rate would not remove these problems but merely suppresses them, until they became so virulent that they erupted, in the form of a currency crisis, or painful domestic adjustment. Flexible exchange rates, in contrast, provided a mechanism for adjustment on an ongoing basis. “Changes in it occur rapidly, automatically, and continuously and so tend to produce corrective movements before tensions can accumulate and a crisis develop. ” Friedman also argued that with good macroeconomic management, exchange rates were unlikely to be very volatile, and very unlikely to burden trade in goods and services, which in any case could avail itself from futures markets to hedge exchange rate risk