Summary: Pursuant to a congressional request, testimony was given concerning the importance of exchange rates to the American economy and the Nation's experience with floating exchange rates. The high value of the American dollar on foreign exchange markets over the past several years has helped to reduce inflation; however, it has also contributed to the depth and duration of the recession by making American goods more expensive than foreign goods. GAO believes that the economies of the United States and other nations are becoming more interdependent and that exchange rates will remain important to the American economy. In 1973, when the United States began to rely on market-determined exchange rates, there was an expectation that, by automatically adjusting exchange rates to the proper levels, nations would have greater freedom to adopt macroeconomic policies in pursuit of domestic targets such as price or employment stabilization or economic growth. However, flexible exchange rates do not remove constraints on economic policy. The increased integration of the U.S. economy with the rest of the world has also changed the domestic effectiveness of monetary and fiscal policies, and market-determined exchange rates can adversely affect firms that engage in international trade. Floating exchange rates can react quickly to many variables including exports, imports, inflation rates, interest rates, and international investment risks. GAO stated that, while the recession demonstrated how economic disruptions spread in an interdependent world, international trade and investments are too vital to the U.S. economy to consider its isolation from the rest of the world. The recession also made clear the need to examine the floating exchange rate system but, due to the complexity of interdependence and the limits of economists' current understanding of exchange rate behavior, no changes to the system have been agreed upon. GAO feels that no new system or alteration to the current system will allow the Nation to escape the constraints of greater interdependence of national economies.
