ResearchBPEA | 1986 No. 1
Target Zones and the Management of the Dollar
1986, No. 1
BY March 1986 the dollar had fallen about 25 percent from its peak level in February 1985. According to the model of Stephen Marris, perpetuation of the rates prevailing last March would leave the U.S. trade deficit well above $100 billion until 1989, when it would start to increase again. A further decline in the dollar will thus be necessary to produce a sustainable current account. My own estimate is that the dollar must fall another 10 percent or so to reach what I term “fundamental equilibrium.” While it is important that the dollar complete its realignment, it is also important that it avoid overshooting, for too low a value would renew inflationary pressure in the United States and increase pressures on employment and the tradable goods industries in other industrial countries. In my view the way to pursue the goal of completing the realignment while avoiding overshooting is by prompt introduction of a system of target zones for the major currencies. In the first section of this paper I outline such a system. In the second section I describe eight factors that lead me to favor this approach. In the final section I examine the relevance of prospects for the U.S. fiscal deficit to the advisability of adopting a target zone approach to currency management.