Determinants of the Choice of Exchange Rate Regime in Resource-Rich Countries

Abstract

This research studies the specific determinants of the choice of exchange rate regime in resource-rich countries. We run multinomial logit regressions for an unbalanced panel data set of 145 countries over the 1975-2004 period. We find that resource-rich countries are more likely to adopt a fixed exchange rate regime compared to resource-poor countries. Furthermore, we provide evidence that output volatility contributes to the likelihood of choosing a fixed exchange rate regime positively in resource-rich countries and negatively in resource-poor countries. We believe that in resource-rich countries a fixed exchange rate regime is mainly preferred due to its stabilization function in the face of turbulent foreign exchange inflows. Moreover, our results reveal that the role of democracy and independent central banks in choosing more flexible exchange rate regimes is stronger in resource-rich countries. In resource-rich countries that possess non-democratic institutions and non-independent central banks, the government is less accountable in spending natural resource revenues and fiscal dominance prevails. In this situation, fluctuations in natural resource revenues are more easily transmitted into the domestic economy and therefore a fixed exchange rate becomes a more favorable option.