Classifying de facto exchange rate regimes of financially open and closed economies: A statistical approach

Abstract

ABSTRACT This paper offers a new de facto exchange rate regime classification that draws on the strengths of three popular classifications. Its two hallmarks are the careful treatment of a nexus between an exchange rate regime and financial openness and the use of formal statistical tools (the trimmed k-means and k-nearest neighbour methods). It is demonstrated that our strategy minimises the impact of differences between market-determined and official exchange rates on the ‘fix’ and ‘float’ categories. Moreover, it is more suited to assess empirical relevance of the Mundellian trilemma and ‘irreconcilable duo’ hypotheses. Using comparative analysis we find that the degree of agreement between classifications is moderate: the null of no association is strongly rejected, but its strength ranges from low to moderate. Moreover, it is shown that our classification is the most strongly associated with each of the other classifications and as such can be considered (closest to) a centre of a space of alternative classifications. Finally, we demonstrate that unlike other classifications, ours lends more support to the Mundellian trilemma than to the ‘irreconcilable duo’ hypothesis. Overall, our classification cannot be considered a variant of any other de facto classification. It is a genuinely new classification. Highlights We develop a statistically-based de facto exchange rate regime classification The trimmed k-means and k-nearest neighbour methods are used Fix and float categories are identified with the correction for financial openness The new classification is a centre of a space of alternative classifications Our classification supports the trilemma rather than irreconcilable duo hypothesis