Exchange Rate Regimes and Business Cycles: An Empirical Investigation

Abstract

This paper empirically investigates the impacts of domestic and external factors along with exchange rate regimes (ERRs) on business cycles in a large panel of advanced and emerging market economies (EME). The results for classical business cycles suggest that EME tend to experience much deeper recessions and relatively steeper expansions during almost the same duration. The probability of expansions significantly increases with ERR flexibility. Our results strongly support floating ERR for both advanced and EME other than the East Asian countries. The impacts of external real and financial shocks and domestic variables are significantly greater under managed regimes as compared to floats. Consistent with an argument that high saving rates enhance the ability of a country to maintain an ERR, managed regimes performs better only in the East Asian countries. Supporting the de-coupling literature, external cycles become insignificant for growth under flexible ERR. Our results strongly suggest that the evolution and determinants of both classical business and growth cycles are not invariant to the prevailing ERR.