To Float or to Trail: Evidence on the Impact of Exchange Rate Regimes

Eduardo Levy-Yeyati,Federico Sturzenegger

doi:10.2139/ssrn.263824

Abstract

We study the relationship between exchange rate regimes and economic growth for a sample of 154 countries over the post-Bretton Woods period (1974-1999), using a new de facto classification of regimes based on the actual behavior of the relevant macroeconomic variables. In contrast with previous studies, we find that, for developing countries, less flexible exchange rate regimes are strongly associated with slower growth, as well as with greater output volatility. For industrial countries, on the contrary, regimes do not appear to have any significant impact on growth. The results are robust to endogeneity corrections and a number of alternative specifications borrowed from the growth literature.

Highlights

The choice of exchange rate regimes and its impact on economic variables is probably one of the most controversial topics in macroeconomic policy
While its implications regarding inflation and policy credibility have received considerable attention, the impact of regimes on economic growth has been the subject of surprisingly little work, probably due to the fact that nominal variables are typically considered to be unrelated to longer-term growth performance
Contrary to what might have been inferred from the literature, we find that, for developing countries, less flexible exchange rate regimes are associated with slower growth

Summary

INTRODUCTION

The choice of exchange rate regimes and its impact on economic variables is probably one of the most controversial topics in macroeconomic policy. Our tests confirm the standard view (and previous empirical work) indicating the presence of a negative link between output volatility and exchange rate flexibility. These results are robust to a number of alternative specifications and other checks. It is important to stress at this point that we do not intend to revisit previous findings in the growth literature nor to assess their sensitivity to various combinations of explanatory variables or to the inclusion of exchange regime dummies We draw on those findings only to obtain a reasonable set of additional controls to use as a benchmark to test whether the exchange rate regime has a significant impact on growth.

THE DATA

EXCHANGE RATE R EGIMES AND GROWTH

ROBUSTNESS

Findings

CONCLUSION