However, the historical experience, even of the world's major currencies - US dollar, Japanese yen or the currencies now merged into the euro, for example - is that a floating regime provides no assurance of a stable real rate. In practice, the market does not steer the rate in a continuously rational manner. There is also a tendency, even if the authorities are prepared to conduct some intervention, for floating rates to overshoot occasionally, especially when at the mercy of potentially massive international capital flows and herding behaviour in financial markets. Indeed, in certain circumstances floating may magnify rather than reduce short-run volatility in competitiveness, thereby unsettling the environment for making judgements about costs and prices, and hence for business planning. BIS Review 17/2002  3  The advantage of a fixed rate is that, if credible (and I take Hong Kong's 18-year track record as a leading example of that), it provides an unambiguous and highly transparent real-time indicator of whether monetary policy is on track or not, as well as a solid anchor for planning purposes. But, as with floating, it provides no assurance of a stable real rate. And the disadvantage is that the entire burden of relative cost-price adjustment falls on domestic costs and prices. Inflation is likely to be more volatile than under, say, inflation targeting accompanied by floating. Moreover, notably, the fixed regime may require downward flexibility of costs and prices if the nominal exchange rate becomes too strong for whatever reason.
This might involve higher rather than lower interest rates because of a risk premium, plus greater uncertainty. Before moving on from the subject of competitiveness, let me leave you with a couple of thoughts. If Hong Kong has, in some underlying sense, been suffering from severe uncompetitiveness, how does one explain the continuing strength of the trade and current account performance...  … and the fact that the pace of recession in Hong Kong over the last two years has not been significantly different from that in a number of other economies in the region? 6  BIS Review 17/2002  I am drawn to conclude that the criticisms of the peg on competitiveness grounds do not stand up too well under scrutiny. Even if the foregoing analysis and discussion does not prove unequivocally that fixing is superior to floating, it does challenge the contention that perceived problems of competitiveness would dissipate if only we had a floating exchange rate. Living with deflation Let me turn now to the other focus of criticism of the monetary regime that I mentioned earlier, namely deflation. There are four main factors which have been contributing to falling prices in Hong Kong. First, there is the state of the global economy. A combination of recession and remarkable success in taming inflation in recent years have left policy makers in several countries facing the unusual situation of deflation. Hong Kong has not been alone, although the process has perhaps been more prolonged here than in many other places.