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In an earlier article in this Journal, Kenneth Rogoff and I observed that only a very few major countries had observed the discipline of fixed exchange rates for at least five years, and that most of those were rather special cases (Obstfeld and Rogoff, 1995). The case that most puzzled us, Thailand, has dropped off the list — with a resounding crash. Even Hong Kong, which operates as a currency board supposedly subordinated to maintaining the Hong Kong-U.S. dollar peg, has suffered continuing speculative pressure in 1997-98, withstanding persistently high interest rates with Beijing’s support. Another currency-board country, Argentina, has now held to its 1:1 dollar exchange rate since April 1991, and so joins the exclusive five-year club. To accomplish that feat, the country has relied on IMF credit and has suffered unemployment higher than many countries could tolerate (nearly 15 percent in 1997). The European Union members that have recently maintained mutually fixed rates have been aided by market confidence in their own planned solution to the policy trilemma, a full currency merger due to be consummated in January 1999. But they too have paid a price in terms of joblessness. The trend toward greater financial openness in developing countries has been accompanied — inevitably, I would argue — by a declining reliance on pegged exchange rates in favor of exchange rate flexibility.

Fiscal Autonomy and Income Distribution

An open capital market immediately confronts national authorities with a decision over controlling either interest rates or exchange rates. Over the medium term, integration into the global capital market also makes it more difficult to tax internationally footloose capital relative to less mobile factors of production, notably labor. This loss of fiscal options could be costly, but just how costly remains unclear.