Abstract
Abstract The literature lacks consensus on the role of currency regimes in explaining external competitiveness. Countries not only differ in terms of currency regimes, but can also have different institutional arrangements, namely trade agreements and inflation targeting (IT) frameworks in addition to the overall quality of governance. Hence, using the real effective exchange rate and by covering 35 developing countries over the period 1975–2014, we investigate the role of currency regimes in explaining the degree of misalignment while considering institutional factors. First, we find that intermediate regimes limit the currency misalignment with greater financial openness (FO). Second, non-reciprocal preferential trade agreements improve price competitiveness, whereas free trade and reciprocal ones can only be beneficial with a higher degree of FO. Third, misalignments in fixed regimes decline in the presence of stronger institutions or in countries with an IT type of monetary policy framework. The above results remain robust to alternative specifications.
Highlights
Many emerging economies such as Malaysia and Thailand, in addition to their more advanced peers (e.g., Singapore, Korea, and Hong Kong), became increasingly competitive in the 1980s and 1990s, due to tradeand investment-related structural changes
In the second stage of the analysis, we aim to investigate whether the misalignment of real effective exchange rate (REER) could be explained by two important aspects: first, the choice of exchange rate regimes and the degree of financial openness are investigated in the benchmark models; and second, the roles of institutional arrangements, namely governance indicators, trade agreements and inflation-targeting-based monetary framework are investigated after the benchmark analysis, in the subsequent subsections
We examined the role of different exchange rate regimes on currency misalignment while considering the institutional arrangements across countries
Summary
Many emerging economies such as Malaysia and Thailand, in addition to their more advanced peers (e.g., Singapore, Korea, and Hong Kong), became increasingly competitive in the 1980s and 1990s, due to tradeand investment-related structural changes. Recent literature argues that structural changes such as institutional arrangements play a crucial role in both growth (see Mullings, 2020) and attracting capital inflows (see for example Bournakis et al, 2018, Agoba et al, 2020) Those inflows in the presence of better institutional quality contribute to the capital stock in those countries (see Nemlioglu and Mallick, 2020; Younas, 2009) as well as their international reserves (see Aizenman et al, 2015), which in turn may contribute to controlling the misalignments in the REER. Overall, using a panel dataset for 35 emerging countries during 1975-2014, this paper examines the effect of currency regimes on external competitiveness by bringing institutional arrangements such as trade agreements, inflation-targeting policies as well as the quality of institutions into a broader framework. We investigate the impact of a monetary policy-induced switch to an inflationtargeting in emerging markets, starting in the 1990s, and find that countries following the IT policy benefit from greater competitiveness through better institutional quality, across different currency regimes. The second section reviews the related literature; the third section presents the data and the empirical strategy; the fourth section outlines the empirical estimation and robustness checks, and the fifth section concludes the paper
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