Grooming Classifications

Abstract

The objective of this paper is to test the exchange rate regime-growth nexus in transition economies by looking at if, and how, some inherent characteristics of the transition process might have affected the classification of de facto exchange rate regimes. Twenty-eight transition countries of Central and Eastern Europe and the Commonwealth of Independent States are investigated over 1991-2007, and three systems for classifying de facto exchange rate regimes are considered. As in the empirical literature, the exchange rate regime effect on growth initially differs depending on the classification system. However, further investigation suggests that the three classification systems differ with respect to some inherent characteristics of the transition process, like the increased trade openness of the countries, episodes of high inflation, banking system reform, and interest rate liberalization. This study's results indicate that high inflation likely caused the disagreement as to how to classify different regimes in the early transition period, while trade openness and interest rate liberalization caused such disagreement in the late transition period. After these points of disagreement are cleared up and potential selectivity bias is corrected for, the final results suggest that in all three classification systems, both pegs and intermediate regimes significantly outperform floats in terms of economic growth—the average effect being slightly lower for pegs.