Exchange Rate Misalignments and Adjustments: Implications for Floating and Fixed Parity Systems

We present a microeconomic efficiency cost framework for discriminating between fixed and floating exchange rate systems, and illustrate it with UK data over 1975–90. It is found that a fixed parity system would have been unambiguously preferred to a floating system over this period, unless the parity were set sufficiently non‐centrally or costs from persistent currency overvaluation were sufficiently high. Under no circumstances could a floating parity have been unambiguously preferred to a fixed parity system.