Discrepancy between exchange rate regime and monetary policy

The essence of the argument in the paper comes from a possible dichotomy between exchange rate and monetary policies. According to the recommendations of the International Monetary Fund many transition economies adopted exchange rate regimes characterized by different degrees of flexibility and management. Several countries, including the Czech Republic, adopted an exchange regime based on a currency basket peg. Such a regime is, according to the International Monetary Fund, characterized as a fixed exchange rate regime. However, a critical difference is that such an exchange rate is actually pegged to a currency basket rather than fixed to one foreign currency. In the case of the fixed regime, a country has by definition an exchange regime policy, gives up its own monetary policy, and the origin of a monetary base is purely a foreign one. The exact opposite is true for a floating exchange regime. A crucial difference arises in the case of a pegged regime whereby a country maintains both exchange rate and monetary policies. Under such an arrangement, eventual conflict between these two policies is likely to materialize due to the both domestic and foreign origin of the monetary base. Such a conflict may eventually evolve into a balance of payments crisis.