Andrew Rose

Olivier Jeanne

Reserve Bank of New Zealand

Both the literature and new empirical evidence show that exchange rate regimes differ primarily by the noisiness of the exchange rate, not be measurable macroeconomic fundamentals. This motivates a theoretical analysis of exchange rate regimes with noise traders. The presence of noise traders can lead to multiple equilibria in the foreign exchange market. The entry of noise traders both create and share the risk associated with exchange rate volatility. In such circumstances, monetary policy can be used to lower exchange rate volatility without altering macroeconomic fundamentals.

Noise Trading and Exchange Rate Regimes

John Williamson

Arvind Subramanian

Most countries emerged from the Second World War with capital accounts that were closed to the rest of the world. Since then, a process of capital account opening has occurred, with the result that all developed and many emerging-market countries now have capital accounts that are both de facto and de jure open, while many developing countries also have de facto openness. This study examines this in part by considering some of the first lessons from the current global financial crisis. This crisis may change the terms of the debate on capital account liberalization in a deeper and more lasting way than any of the crises of the past two decades because it may mark a reversal in the secular trend of financial liberalization at the core of the international financial system. The current crisis also raises new questions about the appropriate policy responses to boom-bust dynamics in domestic credit and in international credit flows. Intellectual consistency is needed between the domestic and international dimensions of financial regulation and the policies aimed at dealing with boom-bust dynamics in domestic and international credit.

Olivier Jeanne

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