Fixed Exchange Rate Arrangement Research Articles

Liquidity Management Under Fixed Exchange Rate with Open Capital Account

This paper introduces a theoretical framework for liquidity management under fixed exchange rate arrangement, derived from the price-specie flow mechanism of David Hume. The framework highlights that the risk of short-term money market rates un-anchoring from the uncovered interest rate parity due to money and foreign exchange market frictions could jeopardize financial stability and market development. The paper then discusses operational solutions that stabilize money market rates close to the level implied by the Uncovered Interest Rate Parity (UIP). Liquidity management under fixed exchange rate with an open capital account presents specific challenges due to: (1) the larger liquidity shocks induced by foreign reserve swings that challenge the development of money markets; and (2) more complicated liquidity forecasts. The theoretical framework is empirically tested based on the estimate of “offset” coefficients for Denmark and Hong Kong SAR.

Liquidity Management under Fixed Exchange Rate with Open Capital Account

This paper introduces a theoretical framework for liquidity management under fixed exchange rate arrangement, derived from the price-specie flow mechanism of David Hume. The framework highlights that the risk of short-term money market rates un-anchoring from the uncovered interest rate parity due to money and foreign exchange market frictions could jeopardize financial stability and market development. The paper then discusses operational solutions that stabilize money market rates close to the level implied by the Uncovered Interest Rate Parity (UIP). Liquidity management under fixed exchange rate with an open capital account presents specific challenges due to: (1) the larger liquidity shocks induced by foreign reserve swings that challenge the development of money markets; and (2) more complicated liquidity forecasts. The theoretical framework is empirically tested based on the estimate of 'offset' coefficients for Denmark and Hong Kong SAR.

The politics of bank ownership and currency policies in Central and Eastern Europe

ABSTRACTThis paper argues that state-owned, private domestic, and foreign banks have different preferences for exchange rate policies. More specifically, I posit that governments will be less willing and able to maintain fixed exchange rate arrangements in closed banking systems dominated by government-owned banks than in globalized banking systems with a large presence of foreign banks. The article’s principal claim rests on the notion that ownership structure of the banking system empowers different types of banks, affects their interests, and shapes the responsiveness of government politicians to bank demands. The bank ownership types further influence the stability of the domestic monetary system and financial regulation that are of paramount importance in the determination of exchange rate regimes. An empirical investigation of data on exchange rate regimes for 25 Central and Eastern European countries provides strong support for the theory. The results are robust to alternative estimation techniques, instrumental variable analysis, and the inclusion of several economic and political variables.

Can Europe Prosper Without the Common Currency? A Historical Perspective

The Eurocrisis displays an astonishing similarity to the causes of the Great Depression in the form of massive current account imbalances, destabilising capital flows, financial fragility, and the commitment to defending a fixed exchange rate arrangement by means of austerity and internal devaluation. From the interwar economic and political disaster Europe eventually drew the lesson that internal balance had to enjoy priority over external balance, giving rise to a three-decade long period of unprecedented economic growth after the Second World War. As Europe has again stumbled into many of the policy errors that caused the Great Depression, it will need to relearn some of these lessons. In particular, the paper suggests that Europeanisation has gone too far and that rather than completing the monetary Union, Europe's prosperity and political stability would be better served by compartmentalisation of financial markets, vertical industrial policies and an escape clause in the common currency allowing for temporary exit in case of fundamental disequilibria.

Sustainability of macroeconomic policies in selected MENA countries: Post financial and debt crises

In the wake of the recent financial and debt crises, the conduct of macroeconomic policies in the emerging MENA economies has recently become critical in determining those countries future economic situation, due to the accumulation since the early 1990s of a sizable level of external debt, and the pursuit by some countries of a fixed exchange rate regime. Using time series econometric models, this study assesses the sustainability of macroeconomic policies in a selected sample of 4 MENA countries. The empirical results point to sustainable fiscal and exchange rate policies in Tunisia and Morocco, and unsustainable external debt and exchange rate policies in Egypt and Jordan. While Egypt has recently moved to a flexible exchange rate regime, if Jordan still opts for maintaining a fixed exchange rate arrangement, it will have to implement crisis-prevention measures, namely by exercising fiscal discipline, and managing properly its external debt and foreign reserves.

Moving Towards Monetary Integration in East Asia: Achieving Economic Convergence in a Game-Theory Framework

This paper considers the current perspective of coordinating efforts to stabilize exchange rates in East Asia, viewed as the first and essential stage of monetary integration process. In this context, the effects of asymmetric demand and supply shocks affecting the two countries are considered, with the help of a game-theory model, and the outcomes from cooperative and non-cooperative fiscal policy responses are analyzed. The properties of fixed-exchange rate arrangements are analytically treated and numerically simulated in a situation where fiscal policies are left as the only device to deal with asymmetric shocks, both on the demand side and the supply side. The model prediction is that both asymmetric demand and supply shocks may be contrasted with the help of fiscal policies, without damaging consequences for the fixed-exchange rate arrangement. The model also suggests that the results will prove better when the fiscal response to the asymmetric shocks is coordinated. Not differently than what happened in Europe following the implementation of end stages of monetary integration, asymmetric fiscal policy response to asymmetric supply shocks may bring about the piling up of huge public debt, and pave the way to sovereign debt crises. Arguably, in such a situation joint fiscal responsibility may help reinforcing the process of integration and convergence.

International fisher effect under exchange rate regime shifts: Evidence from 10 examples

Amonetary union is classified by several authors as an extreme form of fixed exchange rate arrangement. Analyzing exits from monetary unions is, however, demanding. This paper studies the impact of inflation and interest rate differentials on the nominal exchange rate after leaving a form of peg arrangement and moving to a floating regime, as it may serve as a parallel for a monetary union break-up. The theoretical framework is provided by the theory of the International Fisher Effect. We find that countries with rigid exchange rate policy, less frequently adjusted central parity and narrow exchange rate bands experienced sharp depreciation after the shift, but the depreciation was only temporary. In this group of countries the exchange rate adjustment is weakly exogenous to inflation and interest rate differentials. We apply Johansen’s approach to cointegration, based on the estimation of the Vector Error Correction Model, and the Johansen constraint test of exogeneity. There is strong evidence that long...

The exchange rate control - Hungarian experiences

Since the 1990s various kinds of exchange rate regimes have been employed, such as the adjustable peg regime, the crawling peg regime and the so-called ERM II shadow. This article aims at presenting Hungarian experiences concerning the exchange control policy and the effects of its application. Many negative consequences of employing and using a fixed exchange rate arrangement emerged, mostly those related to the limitation of the autonomy of monetary policy and to the danger of speculation in the foreign exchange market, which in 2008 led to abandonment of the forint’s trading band and introduction of the free-float exchange rate regime.

Autonomy and Effectiveness of Chinese Monetary Policy under the De Facto Fixed Exchange Rate System

AbstractThis paper uses monthly data to examine the autonomy and effectiveness of monetary policy in China under the de facto fixed exchange rate arrangement in place from 1998 to 2005. The results obtained from Granger causality tests in a vector autoregression framework indicate that: (i) China actually conducted independent monetary policy during the fixed exchange rate period; and (ii) market‐oriented policy measures are impotent in influencing real output and prices. The framework of the investigation into the autonomy of monetary policy adapts to the Chinese economic condition that primary loan and deposit rates are set by the central bank. Based on the empirical results, the present paper provides alternative strategies to improve the effectiveness of monetary policy in China, including developing the financial system and solidifying microeconomic fundamentals instead of forcing the adaptation of a more flexible exchange rate regime.

Will You Buy My Peg?: The Credibility of a Fixed Exchange Rate Regime as a Determinant of Bilateral Trade

This paper examines the relationship between fixed exchange rate arrangements and trade using a gravity model of international trade together with bilateral trade data from 24 countries from the Caribbean and Latin America for the period 1960-2001. The analysis indicates that a credible fixed peg has a positive impact on the value of bilateral trade. Moreover, the positive impact on trade is more pronounced with a stricter definition of the fixed peg or a longer duration of the peg. This supports the argument that the credibility of an exchange rate peg is an important element to determine bilateral trade. There is, however, no evidence to suggest that a currency union provides additional benefits.

Credibility, Cost of Reneging and the Choice of Fixed Exchange Rate Regime

The choice of exchange rate regime is considered for a small open economy. Assuming that different forms of fixed exchange rate regimes involve different costs of reneging, it is shown that one potential beneficial aspect of joining a monetary union with a common currency is that it is less likely to be exposed to speculative attacks than less formalized fixed exchange rate arrangements.

Currency Unions, Currency Boards and Other Fixed Exchange Rate Arrangements

Currency Unions, Currency Boards and Other Fixed Exchange Rate Arrangements

Exchange Rate Rules and Economic Policy Choices: Lessons from the Spanish and Italian Experiences of the ERM

Turbulence in international financial markets has led to renewed calls for fixed exchange rate arrangements in several parts of the world. Proponents of such arrangements often cite the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS), which from 1979 until 1993 tightly pegged the currencies of member states, as a model, arguing that it produced convergence toward sound economic policies while attributing its collapse in 1992-93 to exogenous factors (the rise in interest rates caused by German unification and some perverse incentives for currency investors entailed in the 1991 Maastricht Treaty). Taking issue with this view, this article argues that the ERM's crisis was at least partly attributable to the system's own rules of adjustment. The basis for this argument lies in an analysis of the policy strategies pursued by governments in two of the ERM's higher-inflation members (Italy and Spain) in the four-year period prior to the crisis. With the lifting of capital controls, ERM rules actually bolstered the ability of these two governments to sustain an unbalanced macroeconomic policy-mix (that is, a restrictive monetary stance without commensurate fiscal restriction) for an extended period of time, while at the same time they limited the room for expansion for governments that were committed to a more balanced policy course. The result was an acute dissociation of exchange rates from the ‘fundamentals’ of member economies that increased speculative pressures, eroded the system's credibility, and set the basis for the crisis. The experience of Spain and Italy in the ERM suggests that, in the absence of capital controls, fixed exchange rate systems that are premised too heavily on the pursuit of monetary orthodoxy in an anchor currency country, are likely to fail.