In the aftermath of emerging market crises from Russia to Asia and Latin America,
there is a quest for better monetary arrangements that are more crisis-proof. Fixed
rates are out, flexible rates are in with a policy focus on inflation targeting.
But there is, of course, the alternative of abolishing exchange rates all together.
This paper revisits the issue of dollarization or currency boards to review what
arguments in the debate stand up. The case for flexible exchange rates emphasizes
the need for a tool to accomplish relative price adjustment. This paper argues that
in an intertemporal perspective most shocks require financing in the capital market
rather than adjustment. Moreover, countries frequently do not use their flexible
rate to play a cyclical role and, as a result, only a pay a premium for the option
to depreciate but do not take advantage of the flexibility; on the contrary, they
engineer systematic overvaluation in the context of inflation targeting.