Introduction

By drawing on the analysis of the role of monetary policy in balance of payments adjustment under different monetary systems and exchangerate arrangements, this study aims at focussing on the crucial issues involved when attempting to set rules for monetary policy coordination in a system of fixed but adjustable exchange rates such as the European Monetary System (EMS). A proper functioning of the balance of payments adjustment mechanism is crucial for the stability of an exchange-rate system. In turn, the proper working of the adjustment mechanism can be sought either through ‘rules’ which make the adjustment automatic or through prompt ‘discretionary’ changes in monetary policy, which requires a close degree of cooperation among the central banks of the member currencies (and the political willingness to subordinate, when necessary, internal objectives to the external constraint).

After recalling the main lessons from the gold standard and the Bretton Woods system, the analysis will focus on the EMS as it works at present. These are all systems of fixed but, in different degrees, adjustable exchange rates. In Section 2 the two main lessons from the earlier international monetary regimes are summarised, that is: first, that in a system of fixed exchange rates the money supply of at least n –1 participants must remain endogenous, if the adjustment mechanism is to work smoothly. To put it differently, a fixed monetary rule for the total stock of money (but not for the domestic component of the monetary base) is incompatible with a system of fixed exchange rates, unless such a rule is reserved (implicitly or explicitly) to a recognised leader of the system.