Why do countries float the way they float?

Abstract

Countries that are classified as having floating exchange rate systems (or very wide bands) show strikingly different patterns of behavior. They hold very different levels of international reserves and allow very different volatilities to the movements of the exchange rate relative to the volatility that they tolerate either on the level of reserves or on interest rates. We document these differences and explore potential causes that have been suggested by the recent theoretical literature. In particular, we explore the role of the pass-through of exchange rate movements into prices and the consequences of currency mismatches in balance sheets, which we associate to a country's ability to borrow internationally in its own currency. We find a very strong and robust relationship between the pattern of floating and the ability of a country to borrow internationally in its own currency. We find little evidence of the importance of pass-through to account for differences across countries with respect to their exchange rate/monetary management.