As the Reagan administration reaches for ways to achieve a more stable dollar and end the costly American trade deficit, we will be hearing more about "target zones" as a method of managing the world's monetary system.
Under "target zones," the United States, Japan, West Germany and other countries would agree to keep their exchange rates within fairly wide zones. They would also agree -- and here's the catch -- to adjust national economic policies when the rates threaten to break out of the accepted range.
Economist John Williamson, a prominent advocate of target zones, points out that this would require politicians to take international considerations into the mix of things when making domestic decisions.
That's a difficult leap forward: if it works, it could help curb volatility in exchange rates. But many, including the West German and Japanese governments, prefer to continue with floating rates, fearing that target zones come too close to the fixed-rate system that broke down in the late 1960s.
Just this week, the International Monetary Fund's executive board held a private discussion of staff papers assessing recent performance of the floating-rate system, and giving the pros and cons for target zones. This is preliminary to a full-blown discussion scheduled by the IMF's interim committee here on April 9.
To be sure, the White House is far from an endorsement of "target zones." But the administration's new emphasis on stability of exchange rates is a complete reversal of an earlier attitude of leaving all to the market to decide. If the now widely divergent views can be compromised, the world may be headed for a new era of "managed" rates, replacing the present hands-off floating system.
That's the main significance of President Reagan's call, in the State of the Union message, for a Treasury study on whether nations should "convene" to discuss the role and relationships of their currencies. It does not mean that he's setting the stage for another Bretton Woods conference.
As economist Edward M. Bernstein, a veteran of Bretton Woods, observed: "They can't ever have another Bretton Woods. They'd have to invite the Russians and 150 developing countries." But the system can be changed without a new global conference under the aegis of the IMF.
Treasury Secretary James A. Baker III, ever the pragmatic genius, doesn't want another huge monetary conference to restructure the system along the lines envisioned by Rep. Jack Kemp (R- N.Y.) and others who still dream of going back to the gold standard.
Baker has a simpler motivation: it would be healthy from the American standpoint if the dollar continued its gentle slide. This would make it easier for American manufacturers to compete in world markets, and facilitate lower interest rates that will be needed in the Gramm-Rudman era to keep the U.S. economy buoyant. Besides, doing something on volatile currency swings has wide bipartisan support: Reagan and Baker can't risk leaving this growing and popular issue to be milked exclusively by the Kemp wing of the GOP.
Baker's Treasury has come a long way since March 15, 1985. That's when he sent a report to Congress asserting that a target-zone approach was not necessary because "the key to stable exchange rates is stable policies and policy expectations and more convergent economic performance in the major industrial countries."
But the dollar remained seriously out of line with other major currencies, even though economic conditions were "converging," until Baker tired of the "hands-off-the-market" approach. In effect, Baker conceded what his predecessor, Donald T. Regan, would not: that excessive volatility in the floating-rate system has had something to do with the trde deficit.
The first thing Baker did was to revitalize the "Group of Five" -- the United States, Britain, France, West Germany and Japan -- whose currencies are at the center of the IMF monetary system. And to the surprise of the rest of the world, the Big Five managed a dramatically successful exercise that extended the decline of the dollar by an additional 10 percent. The success of the Sept. 22 meeting of the G-5 can be attributed in about equal parts to jawboning, intervention in markets and a commitment to joint- policy actions.
But their commitment to greater consistency in economic policies has yet to bear fruit. It would appear that it will be a long time before the two essentials to a further shift in major currency relationships are in place: a significantly lower U.S. budget deficit, and greater fiscal stimulus in Japan and West Germany.
Target zones, which would require a continuous appraisal and negotiation on exchange rates,and close coordination -- especially of central- bank policies -- would go well beyond the recent G-5 agreements.
Nonetheless, Baker appears to be searching for a policy that would lead to this kind of cooperative effort, while shunning labels that might frighten some. If he can pull this off, it would be a spectacular achievement for the second Reagan administration.