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ITF220 Prof.J.Frankel
What exchange rate regimes do countries choose?
1. Classification of exchange rate regimes
INTERMEDIATE REGIMES
ITF220 Prof.J.Frankel
Trends in distribution of EM exchange rate regimes
• 1973-1985 – Many abandoned fixed exchange rates
• 1986-94 – Exchange rate-based stabilization programs
• 1990s -- Corners Hypothesis: countries move to either hard peg or free float
• Since 2001 -- The rise of the “managed float” category.
Distribution of
Exchange Rate
Regimes in Emerging
Markets, 1980-2011
(percent of total)
}
Ghosh, Ostry & Qureshi, 2014,
“Exchange Rate Management and Crisis
Susceptibility: A Reassessment,” IMF.
2. Advantages of fixed rates
2) Encourage investment
3) Provide nominal anchor for monetary policy
• By anchoring inflation expectations, achieve lower inflation for same Y.
• But which anchor? Exchange rate target vs. alternatives.
1) Monetary independence.
2) Automatic adjustment to trade shocks.
3) Central bank retains seignorage.
4) Central bank retains Lender of Last
Resort capability, for rescuing banks.
5) Avoiding crashes that hit pegged rates.
ITF220 Prof.J.Frankel
4. Which dominate: advantages of fixing
or advantages of floating?
Performance by category is inconclusive.
ITF220 Prof.J.Frankel
Optimum Currency Area (OCA)
Broad definition: An optimum currency area is a region
(not necessarily coinciding with one country’s borders)
that should have its own currency & own monetary policy.
ITF220 Prof.J.Frankel
Professor Jeffrey Frankel
Optimum Currency Area criteria
for fixing exchange rate:
• dollarization
(e.g., Panama, El Salvador, Ecuador;
or euro-ization: Montenegro)
• monetary union
(e.g., the eurozone, 1999- ).
ITF220 Prof.J.Frankel
Currency boards
ITF220 Prof.J.Frankel
1990’s criteria for the firm-fix corner
suiting candidates for currency board or union (e.g., Calvo)
Regarding credibility:
• a desperate need to import monetary stability, due to:
• history of hyperinflation,
• absence of credible public institutions,
• location in a dangerous neighborhood, or
• large exposure to nervous international investors;
• a desire for integration with a particular neighbor/ trading partner.
ITF220 Prof.J.Frankel
Two additional considerations,
particularly relevant to developing countries
ITF220 Prof.J.Frankel
(ii) Real Shocks
• An old wisdom regarding the source of shocks:
– Fixed rates work best if shocks are mostly internal
demand shocks (especially monetary);
– floating rates work best if shocks tend to be real
shocks (especially external trade shocks).
• One case of supply shocks:
natural disasters
• Most common case of real shocks: trade
ITF220 Prof.J.Frankel
Appendix I:
Fashions in international currency policy
• The claim:
“Countries can either rigidly peg or freely float,
but should abandon intermediate regimes like target zones.”
• Origins:
• 1992-93 ERM crises -- Eichengreen (1994)
ITF220 Prof.J.Frankel
Intermediate regimes
• target zone (band)
• Krugman-ERM type (with nominal anchor)
• Bergsten-Williamson type (FEER adjusted automatically)
• basket peg
(weights can be either transparent or secret)
• crawling peg
• pre-announced (e.g., tablita)
• indexed (to fix real exchange rate)
• adjustable peg
(escape clause, e.g., contingent
on terms of trade or reserve loss)
ITF220 Prof.J.Frankel
The rise & fall of the Corners Hypothesis
ITF220 Prof.J.Frankel
Appendix III:
De facto classification of regimes
De jure regime de facto
• Many countries that say they float, in fact
intervene heavily in the foreign exchange market. [1]
• Many countries that say they fix, in fact
devalue when trouble arises. [2]
• Many countries that say they target a basket of major
currencies in fact fiddle with the weights. [3]
[1] “Fear of floating” -- Calvo & Reinhart (2001, 2002); Reinhart (2000).
[2] “The mirage of fixed exchange rates” -- Obstfeld & Rogoff (1995).
[3] Parameters kept secret -- Frankel, Schmukler & Servén (2000).
ITF220 Prof.J.Frankel
A number of studies have classified countries
by de facto exchange rate regimes.
But their designations are not highly correlated with each other.
Andrew Rose, 2011, "Exchange Rate Regimes in the Modern Era: Fixed, Floating, and Flaky,” J. Ec. Literature, Vol. 49, No. 3, Sept., pp. 652-672.
Which exchange rate regimes show higher growth on average?
Different classification schemes give different results.
Growth Effects of Deviations from Fixed Exchange Rate Regimes
Andrew K. Rose, 2011, "Exchange Rate Regimes in the Modern Era: Fixed, Floating, and Flaky,”
Journal of Economic Literature, Vol. 49, No. 3, Sept., pp. 652-672. Table 2.