In any case, the problem with the exchange rate choice was not the decision to let the rate adjust, but the decision to resist it and the role that played in magnifying the bubble, and thereby the subsequent damage from the fall. Given where we are today, and what we know about the relative merits of flexible and fixed exchange rate regimes, what is the likely evolution of the current monetary system going forward? A few concluding observations. First, I think it is unlikely that we will see a substantial move toward monetary integration involving the major emerging market economies, in Asia or in the Western Hemisphere. As the economist Peter  2  BIS Review 44/2007  Kenen writes in his latest book, it is difficult today to envisage a substantial reduction in national currencies though the emergence of large regional monetary unions where they do not already exist. Within Europe, we may yet see a further enlargement of the euro area. There may be other circumstances in which individual economies can derive benefit from a currency board system or from dollarization or euroization. Countries trying to emerge from a period of high inflation may in the future, as they have in the past, adopt a fixed exchange rate as a nominal external anchor for a disinflation strategy. These seem likely to be exceptions, however, to a general move toward more flexible exchange rate regimes.
By engineering artificial expectations of stability, the regime had led market participants to disregard the possibility of exchange rate devaluations, leading to mispricing of risk, insufficient hedging and ultimately to misallocation of financial and real resources. Governments that found themselves in this position had very limited ability to mitigate the economic damage that was to come, but the policy choices that accompanied the exchange rate change often compounded the problem. Japan's experience provides another example, though the context was different. There is a perception in parts of Asia that the Japanese government's decision to let the yen appreciate in the late 1980s was principally responsible for Japan's so-called “lost decade” of low growth. And, Japan, viewed through this prism, is cited as an example of the perils of letting an exchange rate move up in response to changing fundamentals. The reality is more complex. The problems of the Japanese economy in the 1990s were largely due to the aftereffects of the collapse of the real estate and asset price boom of the preceding decade, a boom fueled in part by efforts by the monetary authorities to limit the appreciation of the yen. The size of the negative shock to demand from the collapse of the bubble was very substantial, and the capacity of the government and the central bank to mitigate the damage was constrained by the weakness in the banking system. A more forceful macroeconomic policy response, however, might have brought about a quicker recovery.