De Facto Exchange Rate Regimes Research Articles

Why does uncovered interest parity fail empirically?

The Uncovered Interest Parity theory, predicated on perfect capital mobility and a floating exchange rate regime, faces challenges in real-world contexts marked by capital restrictions and diverse exchange rate regimes. This research investigates the validity of the UIP hypothesis in selected OECD countries, considering the role of capital control and de facto exchange rate regimes. By analyzing annual and monthly data, including immediate rates, short-term borrowing rates, and 10-year government bond rate differentials, several panel estimation techniques and alternative empirical models are employed. The results are robust to sub-sample analyses, alternative specifications of the empirical model, and different estimation methods. The study provides evidence supporting the UIP, particularly for immediate and short-term interest rates. The empirical examination underscores the necessity of accounting for the de facto floating exchange rate regime and capital flow restrictions when testing the UIP model. Consequently, the UIP hypothesis moves beyond being a theoretical fallacy and emerges as empirically verifiable, holding significant implications for policymakers and advancing the understanding of international finance.

Output volatility and exchange rates: New evidence from the updated de facto exchange rate regime classifications

This paper raises the question of whether the exchange rate regime matters for output volatility. Using the two de facto exchange rate regime classifications, we demonstrate that the answer to this question is conditional ‘yes’. The key and novel finding is that the exchange rate regime modifies the importance of determinants of output volatility rather than impacts it directly. This point is explained within a microfounded small open economy model and corroborated with empirical evidence for 48 advanced and emerging market economies. We find that under the pegged regime, trade openness contributes to a reduction in output volatility, whereas financial development has the opposite effect. Moreover, large economies experience lower output volatility irrespective of the exchange rate regime, albeit the beneficial size effect is more pronounced under floating rate regimes. The results are robust to the classification employed to identify de facto pegs and floats.

Identifying Algeria’s de facto exchange rate regime: a wavelet-based approach

The Central Bank of Algeria has announced a managed float of the Algerian dinar since 1994. Yet, there are some substantial differences between various de facto classifications of Algeria’s exchange rate regime. This study looks into the exchange rate regime of Algeria, aiming to identify de facto regime. To identify the implicit basket weights for the Algerian dinar, first the OLS rolling window methodology is used to estimate the celebrated Frankel-Wei regression. Then, the wavelet-based methods are applied to study the co-movement patterns of the exchange rates of the Algerian dinar, US dollar, and Euro. In the main, the OLS rolling window results show that the US dollar and the Euro are the currencies with the most influence over the Algerian dinar. Further, from the Wavelet Multiple Correlation (WMC) results, the US dollar is identified as the potential leader in the implicit basket for the Algerian dinar. Additionally, from the Wavelet Local Multiple Correlation (WLMC) results, it is found that the Algerian DZD, US dollar, and Euro are highly correlated, with a correlation value around 0.90 for most of the time scales. Based on the results obtained, we suggest that Algeria’s exchange rate regime could be a crawling peg and band around the US dollar and Euro.

Let it float: new empirical evidence on de facto exchange rate regimes and growth in Latin America

This paper reassesses the evidence presented in Levy-Yeyati and Sturzenegger (LYS) (2003) on the relation between exchange rate regimes and economic growth. We use their de facto classification as well as their database, in order to gain robustness and efficiency in the results. We run System GMM estimations.
 
 Additionally, we focus on Latin American countries for the period 1974-2004. Differently to LYS, our evidence indicates that exchange rate regimes are not significant to explain economic growth, both in a worldwide sample of countries and particularly in Latin America. However, in this region flexible regimes appear to have more advantages in terms of the role of the determinants of economic growth in relation to the other exchange regimes.

Are We Floating Yet? Duration of Fixed Exchange Rate Regimes.

This study examines the duration of fixed exchange rate regimes to determine the factors that impact the probability of an exit from a peg. Using de facto exchange rate regime classification, we find that duration of a peg is non-monotonic. The results of the semi-parametric proportional hazard model highlight that GDP growth and openness decrease the probability of an exit from a peg, while growing unemployment and increasing claims on government increase the likelihood of abandoning a peg. The negative impact of economic growth on the hazard rate is robust when we use marginal risk analysis and net foreign assets and inflation are found to influence the pegged regime duration.

How exchange rate regimes are exacerbating or mitigating the resource curse?

This paper investigates the role of different exchange rate regimes in exacerbating or mitigating the resource curse. The resource curse, in general, and its specific instances such as Dutch Disease may strictly be dependent on the exchange rate movement, which is subjected to the de facto exchange rate regime any country follows, at least in the short run. Using panel data of resource-abundant economies, we structure our model to disentangle the relationship between natural resources and economic growth under different de facto exchange rate regimes. We find that free-float economies are subject to a higher degree of the resource curse. The free-floating exchange rate regime's intrinsic role is conducive to growth, but it can exacerbate the degree of resource curse in resource-rich economies.

Broken Promises: Regime Announcements and Exchange Rates around Elections

We study exchange rate dynamics around government changes conditional on the exchange rate regime, which we identify by combining the IMF de jure and the Reinhart and Rogoff de facto exchange rate regime classifications. This allows distinguishing whether the official exchange rate regime announcements match actual policy or are inconsistent with it. Using monthly data from Latin American democracies, we do not find significant exchange rate depreciations before the change of government in any of the regimes we identify. However, we do detect a gradual real exchange rate overvaluation when the de jure regime is fixed but the de facto policy is flexible, which is abruptly corrected after the change of government; this pattern of real exchange rate misalignments when the announcement does not match actual behavior is linked to incumbents that postpone devaluations until the successor steps in. This pattern of broken promises is typical until 1999, but it becomes exceptional thereafter.

Exchange rate flexibility, the real exchange rate, and adjustment to terms‐of‐trade shocks

AbstractWe study the impact of exogenous terms‐of‐trade shocks in a large sample of small open economies. Using a panel vector autoregression, we estimate the response of domestic variables including the exchange rate, output, exports, imports, and domestic demand, allowing impulse responses to vary according to the de facto exchange rate regime. We find strong evidence that flexible exchange rate regimes play a shock‐absorbing role by reducing the response of output to terms‐of‐trade shocks. Results show that flexible regimes see a stronger response of the real exchange rate and faster external adjustment, suggestive of a mechanism that switches expenditure from imported to domestically‐produced goods.

Classifying de facto exchange rate regimes of financially open and closed economies: A statistical approach

ABSTRACT This paper offers a new de facto exchange rate regime classification that draws on the strengths of three popular classifications. Its two hallmarks are the careful treatment of a nexus between an exchange rate regime and financial openness and the use of formal statistical tools (the trimmed k-means and k-nearest neighbour methods). It is demonstrated that our strategy minimises the impact of differences between market-determined and official exchange rates on the ‘fix’ and ‘float’ categories. Moreover, it is more suited to assess empirical relevance of the Mundellian trilemma and ‘irreconcilable duo’ hypotheses. Using comparative analysis we find that the degree of agreement between classifications is moderate: the null of no association is strongly rejected, but its strength ranges from low to moderate. Moreover, it is shown that our classification is the most strongly associated with each of the other classifications and as such can be considered (closest to) a centre of a space of alternative classifications. Finally, we demonstrate that unlike other classifications, ours lends more support to the Mundellian trilemma than to the ‘irreconcilable duo’ hypothesis. Overall, our classification cannot be considered a variant of any other de facto classification. It is a genuinely new classification. Highlights We develop a statistically-based de facto exchange rate regime classification The trimmed k-means and k-nearest neighbour methods are used Fix and float categories are identified with the correction for financial openness The new classification is a centre of a space of alternative classifications Our classification supports the trilemma rather than irreconcilable duo hypothesis

Do fixers perform worse than non-fixers during global recessions and recoveries?

There is an important debate about how economies with different exchange rate regimes performed during the Great Recession and its ensuing recovery. While economic theory suggests that economies with fixed exchange rates are more affected and recover more slowly from global shocks than economies with non-fixed exchange rates, the empirical evidence on the most recent global recession has been mixed. This paper uses dynamic panel models to examine how the exchange rate and economic growth nexus is affected by the four global recessions and recoveries the world economy has experienced post-Bretton Woods. While there is no robust long-term relationship between exchange rate regimes and growth, there is evidence that fixers recover from global recessions at a weaker pace than non-fixers. These findings are robust across the different de facto exchange rate regime measures.

Investigating De Facto and De Jure Exchange Rate Regimes

Exchange rate regimes have evolved a lot of the years, specifically the past century, right from the Gold standard to the Bretton Woods era that led to the creation of the International Monetary Fund (IMF) and Post Bretton Woods periods that have seen the emergence of currency unions and a whole range of hybrid and more sophisticated exchange rate regimes. This evolution has led to the emergence of de jure and de facto exchange rate regimes. This discrepancy can be very misleading and pervasive for monetary policy and stability. In this paper, we combine an empirical econometric approach to develop an algorithm that will classify the de facto regimes that countries are practising by modelling exchange rate bands and the behaviour of a particular currency towards an anchor. The sample is representative of the globe. We believe the algorithm performs well and may be adopted by monetary authorities and international bodies like the International Monetary Fund.

Exchange rate regimes, devaluations and growth collapses

The loss of output in major recessions tends to be permanent. Using IMF de facto exchange rate regime classifications over the period 1980–2012 for up to 193 countries, it is shown that growth collapses are more frequent under less flexible exchange rate regimes, and particularly hard pegs. Amongst intermediate regimes, those with recent devaluations are less likely to experience a growth collapse, which confirms the role of exchange rate adjustment in reducing the output effects of a negative shock. Our findings are robust to the marked shift in the pattern of growth collapses after the global financial crisis.

A New Approach to Identifying Exchange Rate Regimes

Abstract This publication identifies de facto exchange rate regimes. The study takes into account multiple specifications for the exchange rate regimes, both effective and non-effective. The regimes are classified by means of a three-dimensional clustering approach, that takes the exchange rate volatility, the volatility of exchange rate changes and the volatility of reserves into account. The regimes are classified as floating, dirty floating, crawling peg or fixed. The analysis comprises 90 countries and a span of 35 years. JEL classifications: E42 Keywords: de facto exchange rate regimes, clustering techniques, effective exchange rates

Persistent real misalignments and the role of the exchange rate regime

We assess, for a sample of 54 economies, the impact of de facto exchange rate regimes on both the persistence of real exchange misalignments and the average rate of real appreciation. We find that a fixed exchange rate regime reduces the speed of the real exchange rate’s convergence to its equilibrium level. It also increases the average appreciation rate, but only in the case of developing economies. In developed countries, the real exchange rate dynamics is inelastic to the exchange rate regime.

On the correct model specification for estimating the structure of a currency basket

A strand of literature has focused on inferring the weights of the anchor currencies in a country’s currency basket. With the growing importance of China’s economy, there has been a surging research interest in the role of the renminbi as an international anchor currency and in China’s de facto exchange rate regime. In this article, we show by a simple model and demonstrate using the observed data on the Special Drawing Rights basket that the correct specification to estimate the weights of anchor currencies in a currency basket is to use the rates of change in exchange rates and to write exchange rates in quantity term. When one is to estimate the structure of a currency basket, close attention should be paid to using the rates of change or the levels of exchange rates as well as writing exchange rates in quantity or price term.

De facto exchange rate regimes and inflation targeting in Latin America: Some empirical evidence from the past decade

Este trabajo estima los regimenes cambiarios de facto de las siete economias mas importantes de America Latina (LA-7) entre 1999 y 2011. Se utiliza la metodologia de Zeileis, Shah y Patnaik (2010) que, a diferencia de otras desarrolladas hasta el momento, captura la estructura “fina” de los regimenes cambiarios de facto e identifica quiebres estructurales en fechas precisas. Se concluye que los paises de AL-7 han logrado converger hacia un mayor grado de flotacion cambiaria de facto , aunque existen diferencias en el grado de flexibilidad cambiaria entre los paises que han adoptado esquemas de metas inflacionarias y los que carecen de ellas.

On the Value of Words: Inflation and Fixed Exchange Rate Regimes

To maintain price and exchange rate stability, many emerging market and developing countries (EMDCs) de facto peg their exchange rates, intervening in the foreign exchange markets, but without formally committing to a peg. But in doing so, are they foregoing important benefits in terms of lower inflation? We argue that the de jure commitment, by making exit more costly, imparts greater credibility, which better anchors inflationary expectations, thereby leading to lower inflation than de facto pegging alone. Our empirical analysis, based on a novel data set of IMF de jure and de facto exchange rate regime classifications for 146 EMDCs over 1980–2010, finds that inflation is indeed lower—especially in emerging markets—by some 4 percentage points when the central bank both de jure commits and de facto pegs the exchange rate than when it de facto pegs alone. Thus, analogous to inflation targeting, where the formal commitment to the framework is thought to help anchor inflationary expectations, the de jure commitment to the peg may also be important to reap the full price-stability benefits of pegs.

A Political Explanation for Exchange-Rate Regime Gaps

Why do certain governments often have an actual exchange-rate policy that differs from their official declaration, creating a gap between their de jure and de facto exchange-rate regimes? This article offers a political explanation centered on the need for certain types of government to respond to a broader set of societal actors with different preferences concerning the exchange-rate regime. The argument posits that more democratic governments must respond to a broader set of societal actors, thus leading them to use their de jure and de facto regimes as short-term political substitutes. In using one regime (either de jure or de facto) to appeal to one group of societal actors and the other regime to appeal to another group with different preferences, exchange-rate regimes are hypothesized to be more frequent for more democratic governments. The statistic evidence accords with this expectation.

Duration of fixed exchange rate regimes in emerging economies

This paper examines the duration of fixed exchange rate regimes and investigates whether there is a certain pattern of time dependence in the survival rate of pegged exchange rate regimes for emerging economies. We query why some fixed regimes last longer and determine the macroeconomic, social and political factors that make a pegged regime more durable. We use survival analysis, a technique which accounts for the unobservable cumulative effects associated with maintaining a fixed exchange rate that build up over the duration of a regime. In our model, time enters as a proxy for these unobserved persistent effects as we investigate the relative importance of the fundamentals in the economy on regime durability by considering their relation together with the effect of time itself. Using the de facto exchange rate regime classification proposed by Reinhart and Rogoff (2004), we find non-monotonic duration dependence and show that time is a significant factor for the duration of pegged regimes. Openness, changes in foreign reserves, growth, real exchange rate misalignment, claims on government and sociopolitical instability are also found to influence the pegged regime duration.

Oil price shocks and macroeconomic responses: does the exchange rate regime matter?

AbstractThe sharp fluctuations in oil prices in recent years provide an opportunity to empirically test Friedman's hypothesis that flexible exchange regimes better absorb real external shocks. This paper empirically examines whether the responses of real output, consumer prices, interest rates and real exchange rates differ across exchange rate regimes. Since the effects of oil price shocks depend on whether the economy is a net importer or a net exporter of oil, the sample used in this study is composed of nine Organisation for Economic Cooperation and Development major oil‐importing countries. The results show that only consumer prices and real exchange rates exhibit relatively faster and smoother adjustment to their long‐run equilibrium when the adopted de facto exchange rate regime is flexible, supporting Friedman's hypothesis. Also, panel Granger causality tests suggest a feedback from real effective exchange rates and inflation rates to the real oil price, supporting the argument that oil price shocks are not purely exogenous to developed economies.