Abstract
Most of the empirical literature on the relative merits of alternative exchange rate regimes uses the IMF 'de jure' classification based on the regime that governments claim to have, abstracting from the fact that many countries that in theory follow flexible regimes intervene in the exchange market to an extent that in practice makes them indistinguishable from fixed rate regimes, and vice versa. To address this problem, in this paper we construct a 'de facto' classification of exchange rate regimes. Using cluster analysis techniques, we group different regimes according to their behavior along three classification dimensions: the nominal exchange rate, changes in the nominal exchange rate, and international reserves. We compare our results with the IMF classification, and discuss the main discrepancies. Among other things, our classification finds no support for the hypothesis that intermediate regimes has been disappearing in recent years, and highlights the fact that in practice flexible regimes are restricted to cases of relatively minor exchange rate volatility.
Highlights
The third classification variable, volatility of reserves (MR) is measured as the average of the absolute monthly change in international reserves relative to the monetary base in the previous month in order to proxy the monetary impact of these changes
While the standard discriminant analysis starts from a known classification of the sample to derive a classification rule to be applied to out-of-sample cases, cluster analysis has the advantage that it does not need to know in advance the type of regime we are facing but rather works in the opposite direction, constructing groups according to similarities between the sample elements measured over the three dimensional space defined by the classification variables previously described
The previous discussion indicates the non trivial problems involved in defining classification variables that accurately capture the latent objective function of the central bank
Summary
The proper assessment of costs and benefits of alternative exchange rate regimes has been a hotly debated issue. We think that the distinction between high and low variability countries could be potentially very useful By introducing this variability dimension, this new methodology has the advantage that it allows to incorporate to the econometric analysis the intensity of the shocks to which the regime is subject, something that qualitative indexes previously used did not allow for. This may turn out to be relevant for the empirical analysis as a way of testing whether the policy response under different exchange rate regimes, and their impact on other variables, depends on the relative magnitude of underlying shocks.
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