The case for exchange rate volatility

While some people view exchange rate fluctuation as detrimental to the economy, it is, in fact, a crucial element of economic flexibility

- K P KRISHNAN

In a recent interaction with the public, the leadership of the Reserve Bank of India (RBI) spoke with some pride about the exchange rate stability of the past couple of years. Is this actually a matter to be proud of? In the language of the computer revolution, is this a feature or a bug? First, let's examine the facts.

The top graph (Rupee-dollar dynamics) shows a flat patch, where the USD/INR exchange rate stopped moving much. The bottom graph shows a longer historical perspective. The last time a similar flat patch was found in history was around 2006. After a long history of government control of the exchange rate, India took a big step forward to becoming a market-oriented economy, with the decontrol of the exchange rate. Now, we are back to de-facto government control of an important price in the economy.