exchange rate regime

One hypothesis in the international finance literature is that fixed exchange rate regimes would increase countries’ vulnerability by leading companies to disregard the exchange rate risk, biasing their borrowing towards foreign currency denominated debt 5 , and/or reducing their hedging activities. According to this hypothesis, floating regimes would help to reduce countries’ vulnerability by inducing creditors and debtors to take seriously their exchange rate exposure. On the other hand, the so-called ‘original sin’ 6 theory argues that, independently of the exchange rate regime, emerging countries will always be vulnerable to external shocks. There will always be a currency mismatch on companies’ balance sheets, since domestic companies would never be allowed to borrow in the domestic currency, and most of their revenues come from domestic activities. In a similar way, Calvo and Mishkin (2003) argue that the construction of healthy macroeconomic institutions would be the key to countries’ macroeconomic stability, and the choice of the exchange rate regime would likely be of second order importance to alleviate countries’ external vulnerability 7 .

that countries with flexible exchange rate regimes tend to benefit and develop along with achieving tremendous growth [5]. For developing countries static exchange rate regime tend to keep durability and low level of inflation, however the flexible regime tends to develop the financial sector and make them more resistant to the crisis and shocks. Advanced countries have achieved more flexible exchange rate regime which makes their growth gains remarkable [6]. Meanwhile, the economies opting for a more flexible exchange rate regime are attributed with the strength to absorb and resist trade shocks, also such an economies show growth rate at a high speed as compared to those following the static exchange rate. This also effects the industrial production as well as the employment levels in the economy [7]. In general the countries with higher level of industrial structure are practicing flexible exchange rate regime and are recognized as advanced or developed countries while the developing one are operating in their financial market under fixed exchange rate regime. This relationship is very interesting and shows the internal strength of the economy with the evolution of its financial market. In this paper we are going to empirically examine the relationship between the choice of an exchange rate regime and industrial structure of the economy. Next part will explain the variables examined, followed by data description and results. Last part will present the conclusive remarks.

This study empirically finds the appropriate exchange rate regime for economic structure of Pakistan. To find long run association between exchange rate regime and its determinants; ARDL bond testing approach is concern however for the estimation of short run analysis Error correction model (ECM) is applied. Time series data is used over the period from 1984 to 2012. Findings reveal that Trade openness, foreign exchange reserves, rate of inflation and financial development are important determinant while choosing appropriate exchange-rate regime for economy having features like Pakistan. On the basis of analysis, this study suggests that both extreme ends hard peg and free float are unfavorable for it. Still, lot of attention is required on this topic. Choice of regime is a difficult task in empirical analysis because few factors cannot explain actual regime.

modern era, many countries have switched from one type of exchange rate regime to another and often have flipped back and forth another time or two. Since most of the countries in the world didn’t cast off the chain of gold standard and had spent decades under the Bretton-Wood system, theories and empirical studies about the choice of exchange regimes have not sprung up until early 1980s. Conventional studies concerning what determines a country to adopt fixed or floating exchange rate system have investigated a wide variety of factors in different categories. Most of them have interpreted the reasons from the monetary perspective and the need for more trade. This paper tries to

With capital controls in place, we find that indeterminacy depends upon how inflation and output gap coordinate with each other in their feedback to interest rate setting in the Taylor rule. When forward-looking, both passive and positive monetary policy feedback can lead to indeterminacy. Compared with flexible exchange rates, fixed exchange rate regimes produce more complex indeterminacy conditions, depending upon the stickiness of prices and the elasticity of substitution between labor and consumption. We find Hopf bifurcation under capital control with fixed exchange rates and current-looking monetary policy. To determine empirical relevance, we test indeterminacy empirically using Bayesian estimation. Fixed exchange rate regimes with capital controls produce larger posterior probability of the indeterminate region than a flexible exchange rate regime. Fixed exchange rate regimes with current-looking monetary policy lead to several kinds of bifurcation under capital controls.

There exist several statistically-based exchange rate regime classifications that disagree with one another to a disappointing degree. To what extent is this a matter of the quality of the design of these schemes, and to what extent does it reflect the need to supplement statistics with other information (as is done in the IMF’s de facto classification)? It is shown that statistical methods are good at the basics (distinguishing some type of peg from some type of float), but less helpful in other respects, such as determining whether a float is managed, particularly for countries that are not very remote from their main trading partners. Different measures of exchange rate volatility have been used but are not primarily responsible for differences between classifications. The theoretical underpinning of particular classification schemes needs to be more explicit.

This originates from the works of Mundell (1961). It relates the choice of exchange rate regime to some long run determinants that are relatively stable over time. The OCA theory argues that low degree of openness and large size of an economy measured by Gross Domestic Product should favour floating exchange rates (Mundell, 1961 and Mckinnon, 1963). Modifying these submissions, (Fischer, 1977 and Marston, 1981) in their own views emphasized the place of size and nature of economic shocks as potential determinants of exchange rate regime choice. (Edwards, 1996 and Corden, 2002) argue that openness may provide an incentive to maintain fixed exchange rates. (Eichengreen and Masson, 1998, Mussa et al., 2000) have proceeded in their own contributions to emphasize that foreign shocks are more important in countries with open economies and hence floating exchange rate will be appropriate as a shock absorber. Furthermore, (Juhn and Mauro, 2002) argue that openness itself might be endogenous to the choice of exchange rate regime. Other theoretical and empirical studies have tried to analyse the impact of identified explanatory variables on observed exchange rate regime choice by considering certain OCA variables such as openness, gross domestic product (GDP), GDP per capita and geographical concentration of trade.

Published By policy. This arrangement prevents Namibia from exercising any discretionary monetary policy, meaning that Namibia cannot use monetary policy independently to influence the economy. The lack of the nominal exchange rate becomes more of a trouble and costly when Namibia and South Africa get affected differently by external shocks. Namibia and South Africa have different economic structure, the Namibia’s production and export base is narrow being heavily dependent on minerals and agricultural production. Whereas the South African economy is extremely diversified, it’s having a wide base with regards to its mineral, agricultural, and manufacturing production. As a result, Namibia is at a greater risk of facing different shocks, dissimilar to those of South Africa. In 1994 South Africa changed its exchange rate regime from a pegged exchange rate regime to a flexible exchange rate regime, adopting inflation targeting as its monetary framework. Consequently, as a way of mitigating shocks, Namibia has resorted to fiscal deficits that are largely financed through borrowing, resulting in the lowering of international reserves and high debts. Namibia has been experiencing a persistent capital outflow, as a result of excessive foreign currency outflow to South Africa and slow foreign inflows mainly by the current account of the balance of payment. This led into a decline in foreign reserves in Namibia. An outflow of capital could mean that South Africa would have more funds for investment and development leading regional disparities.

Which exchange rate arrangement is best? This survey historically agrees with Frankel (1999) who states that “no single currency regime in best for all countries and that even for a given country it may be that no single currency regime is best for all time.” However the world is evolving towards a floating exchange rate regime which is the regime of the advanced countries which in many ways echoes the movement towards the gold standard a century ago. The principal exception to the pattern seems to be currency unions such as EMU which the European countries have joined ( largely for political reasons) as have a number of small very open economies.

q   Open    Nfa   Prod   Gov   Tot    Reg1   Reg2 (13). In this equation, Open is the rate of openness of the economy, which reflects the influence of the country's trade policy. Its increase leads to a moderation in the rise of domestic prices, which tends to depreciate the currency (Goldfajn and Valdes, 1999). The variable is the net external position, defined by the determinants of domestic saving and investment. It is assumed that there is a positive relationship between this variable and the REER. The relative productivity of the country (Prod) captures the Balassa-Samuelson effect. This consists of a real appreciation following an increase in productivity in the exposed sector, compared to the rest of the world. There is a positive relationship between this variable and the TCR (Béreau et al., 2010). Gov, represents government consumption expenditure. Most public spending is considered to be for the purchase of non-tradable goods, so that an increase in public consumption leads to an increase in the demand for these goods, leading to an increase in their prices and a real appreciation (Chinn, 1999). For the variable Tot which represents the terms of trade, defined as the ratio of export prices to import prices, it is difficult to determine their a priori effect on the TCR. Moreover, we introduce two indicator variables Reg1 and Reg2, to capture the heterogeneity of the panel linked to the belonging or not to a fixed exchange rate regime. Thus, Reg1 = 1 if the country is under a fixed exchange rate regime and Reg1 = 0 otherwise (inversely for Reg2). Due to the controversy over the effect of the exchange rate regime on real exchange rate volatility (Obstfeld and Rogoff, 1995), we do not expect any particular signs about these variables.

Rodrick and Devarjan(1990) focused on the CFA zone .The zone has maintained a fixed parity with the french franc throughout its history. The relative performance of zone members vis-a-vis their african counterparts illustrates the tradeoffs involved. On the one hand, zone members enjoyed lower inflation thanks to the fixed exchange rate regime. On the other hand, they have apparently been unable to adjust their economies to the large terms of trade shocks of the l980s and have experienced greater variability in output. One reason, is their inability to use nominal exchange rate as an instrument of adjustment.The experience of the CFA zone illustrates the main trade off involved in the choice of exchange rate regimes.By committing themselves to a fixed-rate regime, these countries could anchor their price levels and maintain inflation close to the rate experienced by the country whose currency serves as the peg.  However, by doing so they lost the ability to adjust to terms of trade shocks. Had they selected a flexible-rate regime, they would have been able to limit the damage done to the real economy by the ups and down in the world prices of their main imports and exports.That in turn, would have come at the expense of a higher rate of inflation, as domestic wage and price setters would have lacked the discipline, and domestic monetary authorities the credibility provided by an irrevocably fixed exchange rate .The policymaker is interested in maximizing an objective function in which both a nominal and a real variable play a role. They cast the model in terms of growth and inflation. They express the objective function in quadratic-loss form:

Besides, the exchange rate represents the relative price of domestic currency and foreign currency, which assumes the responsibility of association with home economics and foreign economics and facilitation for internal and external equilibrium. In these literatures, the effect of fiscal policy on floating exchange rate regime has widely discussed (for instance, (Pitterle and Steffen, 2004a;2004b; Tervala, 2008; ANYANWU et al., 2017; Hsiao et al., 2017; Liu et al., 2017)). However, under the fixed exchange rate system, the exchange rate cannot provide the function of transmission, then what effect fiscal policy will have on the macroeconomic variables lacks a complete discussion. In addition, consumption home bias is a common phenomenon in the society, which explains consumers usually are inclined to have a preference for domestic goods. Therefore, this paper tries to analyze the fiscal expenditure shock on macroeconomic variables under the fixed exchange rate system and make a statement of the role of consumption home bias.

In Table 2, regression [2.1] illustrates the absence of a linear e¤ect of the exchange rate regime on productivity growth. This result is consistent with many previous studies. In contrast, regression [2.2] shows that the interac- tion term of exchange rate ‡exibility and …nancial development is positive and signi…cant. The more …nancially developed an economy, the higher is the point estimate of the impact of exchange rate ‡exibility on productivity growth. Furthermore, the combined interacted and non-interacted coe¢ - cient of ‡exibility becomes signi…cant at the 5% level (as indicated by the Wald Test in Table 2). Combining these two terms enables us to identify a threshold of …nancial development below (above) which a more rigid (‡exi- ble) regime fosters productivity growth. The point estimate of the threshold is close to the sample mean of the …nancial development measure. In regres- sions [2.3] and [2.4], we introduce the crisis dummy described above. While the frequency of crisis has indeed a negative impact on productivity growth, the non-linear e¤ect of exchange rate regime on growth remains robust and its point estimate stays almost unchanged.

In this context, we extend the previous literature in the following two dimensions. First, we deal with a wide range of debt levels in order to investigate whether and how the degree of foreign currency debt affects balance sheets and welfare under different exchange rate regimes. Second, we evaluate the welfare properties of exchange rate regimes by employing a model that generates more realistic exchange rate volatility. To the best of our knowledge, few previous studies in this field consider these two issues. Regarding the former, most of the previous studies – with the noteworthy exception of and Tchakarov (2007) - do not examine the welfare implications of various debt levels under different exchange rate regimes. They deal with at most two steady-state calibrations of the debt level. 5 Thus, they do not present convincing answers to the question of what type of exchange rate regime is more suitable for EMCs when the level of foreign currency debt is low or high. With respect to the latter, since most of the existing studies assume a stable relationship between the nominal exchange rate and the nominal interest rate, their models generate predicted exchange rate volatility that is extremely low, compared to that seen in historical data (log-linearizing their models, the path of the nominal exchange rate basically depends on the standard UIP, uncovered interest parity, condition). Therefore, the impact of exchange rate variability on balance sheets could be

Thus far, there appears to be a case for allowing a substantial degree of flexibility in Pakistan’s exchange rate. But our results also indicate that Pakistan suffers from the typical developing country syndrome of real exchange rate depreciations having a contractionary effect on domestic demand. This effect appears to be large enough to more than offset the positive effect of currency depreciation on output coming from an improvement in net exports. Thus, on net, exchange rate flexibility may not help stabilize output, even if it stabilizes the trade balance. The negative effect on domestic demand of currency depreciation probably is a reflection of the special problems that Pakistan has historically shared with many developing countries—currency mismatches on domestic balance sheets resulting from an inability to borrow long term in domestic currency, “fickle and moody” international capital flows that are subject to sudden starts and stops, and lack of credibility and stability of domestic policies. The history of these problems, and the resulting implications, makes the case for substantial flexibility of exchange rates mixed. However, if the recent improvements in the stability and credibility of macroeconomic policies continue, this should bolster the case for a more flexible exchange rate regime going forward.

After more than 40 years of the current monetary system, the issue of the optimal choice of the exchange rate regime remains unresolved. Indeed, we experienced a diversity of regimes and an instability of the choices made with many countries switching from one regime to another. The paper investigates empirically the possible link between financial development and the choice of optimal exchange rate regime. To measure financial development, we introduce a composite index via the aggregation of five indices representing the key characteristics of the financial system in 51 developing countries over the period 1996-2007. The aim is to better consider the multidimensional dynamics of financial sector development. We use a multinomial logit model with panel data of the same countries and period. We consider two classifications of exchange rate regimes: “de jure” and “de facto”. The results suggest that financially developed countries are more likely to adopt the floating regime. It appears also that the choice of a floating regime is, notably, enhanced by financial openness and financial markets development.

The de jure exchange regime for the Indian rupee is that of a managed float since 1994. However, regression results for India suggest that there has been a cycle of inflexibility and greater flexibility, with five distinct breaks in the exchange rate regime. There was a long period of peg to the usd with an R 2 of 0.84 till January 1994. The rupee value went back to a hard peg to the usd , taking the R 2 of 1 till February 1995. Since then there has been greater flexibility in the rupee with both the beta coefficient on the usd and the eur being significant. The rupee appears to have moved to a basket peg since April 2004 and on 23 March 2007, a further move towards flexibility came about. There are substantial differences between this history of the exchange rate regime, when compared with official statements and dates.

smaller. This is opposite to the prediction of standard optimal currency area theory. In the case where regional goods are less perfect substitutes, there are not strong gains from shifting labor to the most productive region since the good produced there would have diminishing returns in consumption. For symmetry, we consider the case where α = .6, so elasticity of substitution is 2.5. The productivity benefits of exchange rate flexibility are smaller; expected utility is only marginally greater than the non-stochastic steady state allocation under flexible exchange rates. Under fixed exchange rates, welfare is smaller than the steady state when ϕ is large enough (greater than 4) as the fixed exchange rate creates a misallocation of labor to low productivity regions. When ϕ = 1, the labor allocation under flexible exchange rates is less asymmetric than the allocation under fixed exchange rates. Since the relatively symmetric allocation is more in line with worker preferences, the productivity benefit aligns with the worker preference benefit. The relative costs of the misallocations of labor under the fixed exchange rate regime increase when labor stability is preferred; cl F LEX − cl F IX increases as ϕ rises. When α is small, we get similar results about the

This paper takes a new empirical approach to analyze the regime transition dynamics. The trend of exchange rate regime distribution can be better judged by the mean duration of each regime among countries over a period of time, rather than analyzing the percentage of regimes in a static manner (Figure 1 A & B). Figure 1A shows that the percentage of intermediate regime has decreased in 1999 than those in 1980 and in 1990, but Figure 1B shows that the percentage of intermediate regimes remained almost the same in the 1980s and 1990s. This may not be correct because percentage of regimes at a point in time or over a period of time may not better reflect the distribution of regimes as countries move back and forth between regimes. This paper therefore attempts to analyze exchange rate regime durability to shed some insights into the choice of exchange rate regime. The paper mainly addresses two issues: (i) whether there is any pattern in the mean duration of regimes over time, and (ii) whether the duration of regimes has any particular links with the level of economic development. Mean duration of regimes is estimated from a fitted covariate dependent and continuous time Markov chain model (the model is discussed in Section 2). Many authors link longer durability of a regime with better performance of that regime. Husain et al. (2005) find that fixed regime is the longest durable regime, but their performance varies with the level of economic development.

Chinese’ exchange rate regime was studied by Frankel and Wei (1994, 1995, 2007), Frankel (2006), Ogawa (2006), Eichengreen (2006), Yamazaki (2006), Goldstein and Lardy (2006), Laurenceson (2008), Levy-Yeyati & Sturzenegger (2003), Ogawa and Yoshimi (2008), Ohno (1999), Zeileis (2009), Evenett (2010), Mele (2010), Mele and Baistrocchi (2012), Yi (2013) and Cui (2014) and these analyzes have been internationally accepted economic literature. However, the consideration of numeracies, especially as a factor necessary to carry out the exchange rate was in our opinion, subject to an error. In particular, although the models used have leveled the problem of volatility through the use of logarithms, the first difference, the use of models in time-series (GARH, AR or the ARIMA), in our opinion, it was always present. In the analysis, therefore, the presence of volatility generates distortion in the results: A higher volatility means that a value can potentially be spread out over a larger range of values. This means that the price change dramatically over a short time period in either direction. The assertion is true not only for financials but also for currencies because the exchange rate in the economy is also a price: The price of one currency in terms of another currency. The analysis, therefore, econometrics or statistics should try to level as possible the presence of volatility.