Currency Misalignments and Exchange Rate Regimes in Emerging and Developing Countries*

Pegged exchange rates are often pointed out as more prone to risk of overvaluation, because their real exchange rates have a tendency to appreciate. We check this assumption empirically over a large sample of emerging and developing countries, by using two databases for de facto classifications by Levy‐Yeyati and Sturzenegger (2003 ) and by Reinhart and Rogoff (2004 ). We assess currency misalignments by estimating real equilibrium exchange rates taking into account a Balassa effect and the impact of net foreign assets. Pegged currencies are shown to be more overvalued than floating ones.     

LATIN AMERICAN EXCHANGE RATE DEPENDENCIES: A REGULAR VINE COPULA APPROACH

This study implements a regular vine copula methodology to evaluate the level of contagion among the exchange rates of six Latin American countries (Argentina, Brazil, Chile, Colombia, Mexico, and Peru) from June 2005 to April 2012. We measure contagion in terms of tail dependence coefficients, following Fratzscher's (1999) definition of contagion as interdependence. Our results indicate that these countries are divided into two blocks. The first block consists of Brazil, Colombia, Chile, and Mexico, whose exchange rates exhibit the largest dependence coefficients, and the second block consists of Argentina and Peru, whose exchange rate dependence coefficients with other Latin American countries are low. We also found that most of the Latin American exchange rate pairs exhibit asymmetric behaviors characterized by nonsignificant upper tail dependence and significant lower tail dependence. These results imply that there exists contagion in Latin American exchange rates in periods of large appreciations, whereas there is no evidence of contagion during periods of currency depreciation. This empirical regularity may reflect the “fear of appreciation” in emerging economies identified by Levy‐Yeyati, Sturzenegger, and Gluzmann (2013). (JEL C32, C51, E42)     

On the Exchange Rate as a Nominal Anchor: The Rise and Fall of the Credibility Hypothesis

The credibility hypothesis, which was used to support the use of a pegged exchange rate arrangement as a nominal anchor mechanism, is based on restrictive analytical foundations that circumscribe its real world applicability. While all pegged exchange rate arrangements are subject to circumstances that can undermine the sustainability of the peg, exchange rate nominal anchor pegs are especially fragile because such arrangements introduce problems that are endogenous to that particular type of regime. The East Asian crisis is used to demonstrate the fragility of exchange rate nominal anchor pegs, while the case of Australia demonstrates how a floating currency escaped the contagion of the East Asian crisis.     

The East Asian Dollar Standard, Fear of Floating, and Original Sin

Before the crisis of 1997/98, the East Asian economies—except for Japan but including China—pegged their currencies to the US dollar. To avoid further turmoil, the IMF argues that these currencies should float more freely. However, the authors’ econometric estimations show that the dollar's predominant weight in East Asian currency baskets has returned to its pre‐crisis levels. By 2002, the day‐to‐day volatility of each country's exchange rate against the dollar had again become negligible. Most governments were rapidly accumulating a “war chest” of official dollar reserves, which portends that this exchange rate stabilization will come to extend over months or quarters. From the doctrine of “original sin” applied to emerging‐market economies, the authors argue that this fear of floating is entirely rational from the perspective of each individual country. And their joint pegging to the dollar benefits the East Asian dollar bloc as a whole, although Japan remains an important outlier.     

MONETARY CREDIBILITY VS. VOTER APPROVAL: POLITICAL INSTITUTIONS AND EXCHANGE‐RATE STABILIZATION DURING CRISES

This paper analyzes how political institutions affect the execution of exchange‐rate policy. By focusing on policy‐makers' responses to the emergence of speculative pressure on their currencies, we argue that the effect of democratic institutions on exchange‐rate stability is likely to be conditioned by the officially announced exchange‐rate regime. Officially fixed exchange rates are the main instrument of autocrats to signal commitment to long‐term stability. Autocratic governments with strictly fixed exchange rates are thus more likely to defend their exchange rates than autocrats with an intermediate regime because the latter implicitly signal that they care less about monetary stability. In contrast, democrats defend more often in intermediately than in fully fixed official regimes by using a combination of external and internal adjustments, which reduce the negative effects of a devaluation on voters. Our analysis of 189 currency crises between 1975 and 1999 supports this conditional effect.     

The illusive quest: Do international capital controls contribute to currency stability?

We investigate the effectiveness of capital controls in insulating economies from currency crises, focusing in particular on both direct and indirect effects of capital controls and how these relationships may have changed over time in response to global financial liberalization and the greater mobility of international capital. We predict the likelihood of currency crises using standard macroeconomic variables and a probit equation estimation methodology with random effects. We employ a comprehensive panel data set comprised of 69 emerging market and developing economies over 1975–2004. Both standard and duration-adjusted measures of capital control intensity (allowing controls to “depreciate” over time) suggest that capital controls have not effectively insulated economies from currency crises at any time during our sample period. Maintaining real GDP growth and limiting real overvaluation are critical factors preventing currency crises, not capital controls. However, the presence of capital controls greatly increases the sensitivity of currency crises to changes in real GDP growth and real exchange rate overvaluation, making countries more vulnerable to changes in fundamentals. Our model suggests that emerging markets weathered the 2007–2008 crisis relatively well because of strong output growth and exchange rate flexibility that limited overvaluation of their currencies.     

关于货币危机后经济衰退的经验分析

文章以1990年以来的近200次货币危机为样本,对货币危机后的经济衰退进行了经验分析.研究发现,危机前的经常账户状况、外债余额占GDP比例、国际流动性指标等经济变量以及危机后的汇率制度都不会显著影响到危机后的经济衰退.另外,危机后的经济衰退与危机国政府在危机中是否抛售外汇储备、是否采取汇率贬值都没有明显关系.但是经济分析的结果表明,危机前的失业率和汇率制度以及危机中是否提高利率等因素对危机后的经济衰退有显著作用.     

Fiscal Uncertainty and Currency Crises

Fiscal deficits have been put forward as the main factor in the occurrence of currency crises by the first‐generation currency crisis models. While most papers within this framework consider a fiscal deficit that occurs with certainty, in reality an increase in the government's fiscal burden may be an uncertain outcome. This paper introduces a model where there is uncertainty about the occurrence of a fiscal deficit for a finite number of periods, and studies the effects of such uncertainty on the evolution of currency crises. If the fiscal deficit materializes, the government has to abandon the fixed exchange rate regime, as in the standard case. However, the paper shows that the peg becomes unsustainable even if the fiscal deficit never materializes. Therefore, a speculative attack occurs and the fixed exchange rate regime collapses with the mere possibility of a deficit, independently of whether this outcome actually occurs or not.     

Fiscal Uncertainty and Currency Crises

Fiscal deficits have been put forward as the main factor in the occurrence of currency crises by the first‐generation currency crisis models. While most papers within this framework consider a fiscal deficit that occurs with certainty, in reality an increase in the government's fiscal burden may be an uncertain outcome. This paper introduces a model where there is uncertainty about the occurrence of a fiscal deficit for a finite number of periods, and studies the effects of such uncertainty on the evolution of currency crises. If the fiscal deficit materializes, the government has to abandon the fixed exchange rate regime, as in the standard case. However, the paper shows that the peg becomes unsustainable even if the fiscal deficit never materializes. Therefore, a speculative attack occurs and the fixed exchange rate regime collapses with the mere possibility of a deficit, independently of whether this outcome actually occurs or not.     

Asian Currency Crisis and the International Monetary Fund, 10 Years Later: Overview*

This paper is an overview of the Asian currency crisis in Thailand, Indonesia, and South Korea in 1997–1998, with an emphasis on the role of the International Monetary Fund (IMF). It provides a detailed account of the development of the crisis and analyses and evaluates the content of IMF advice and its consequences. The size of the IMF package for each of these three countries is judged to have been too small. This paper also has a comparative perspective; the Mexican crisis is reviewed as a precursor to the Asian crisis to see what the IMF learned, and how it prepared, for future crises. The causes of the crises and IMF conditionality for the post‐Asian crisis countries, Russia, Brazil, Turkey, and Argentina, are also compared to the Asian crisis countries. By agreeing to maintain a fixed exchange rate, for example, the IMF is judged to have been “softer” in its approach to the post‐Asian crisis countries.     

Exchange rate regime,real misalignment and currency crises

Based on 69 sample countries, this paper examines the effect of macroeconomic fundamentals on real effective exchange rates (REER) in these sample countries. Using the misalignment of actual REER from its equilibrium level, we have estimated the factors explaining the extent of currency over- or under-valuation. Overall, we find that the higher the flexibility of the currency regime, the lower is the misalignment. The estimates are robust to different sub-samples of countries. We then explore the impact of such misalignment on the probability of a currency crisis in the next period, indicating the extent to which misalignment could be used as a leading indicator of a potential crisis. This paper thus makes a new contribution to the debate on the choice of exchange rate regime by bringing together real exchange rate misalignment and currency crisis literature.     

Choice of Exchange Rate Regime: Currency Board (Hong Kong) or Monitoring Band (Singapore)?

Following the East Asian crisis, a number of observers have advocated that small and open economies in Asia adopt an irrevocably fixed regime. Such a hard peg, it is argued, signals greater commitment to rule out arbitrary exchange rate adjustments as well as the authorities’ willingness to subordinate domestic policy objectives such as output and employment growth to the maintenance of the pegged exchange rate. But is this a reasonable position to adopt? In order to answer this question, we consider and contrast the experiences of Hong Kong and Singapore. While both of these economies share a number of broad similarities, the former operates a US dollar–linked currency board arrangement and the latter maintains an adjustable peg in the form of a monitoring band arrangement with the central parity based on an undisclosed trade–weighted currency basket.     

放弃成本、政府偏好与资本控制:一个审慎的机会主义汇率制度选择模型

本文在Obstfeld(1 996)第二代货币危机模型的基础上 ,建立了一个考虑经济结构、供给冲击以及金融风险的多因素汇率制度选择模型 ,以成本分析为工具解释了资本控制、各类成本和政府偏好对均衡的影响以及对汇率制度选择的影响。研究表明 :(1 )资本控制可以通过多种途径对均衡产生影响 ,在一定条件下可以利用资本控制措施使经济避免多重均衡 ;(2 )放弃成本对汇率制度选择发挥关键作用 ;(3 )较大的政府偏好促使政府选择固定汇率制度 ,在放弃成本不足够大的条件下 ,决策者也可以通过提高政府偏好或者实施资本控制措施来保护本国固定汇率制度 ;(4)对人民币现行汇率制度的放弃成本的估计表明 ,当前人民币汇率制度放弃成本正处于中间水平 ,因此有必要增大政府对固定汇率制度的偏好并且对资本帐户实施适度管理以保持人民币汇率的稳定 ,防范金融风险。至于未来人民币汇率波动幅度的扩大、资本项目自由化的进程以及人民币汇率制度何时回归真正的“管理浮动” ,应主要取决于人民币汇率制度放弃成本的有效降低     

Explaining ERM realignments: Insights from optimising models of currency crises

This paper attempts to provide empirical evidence on the determinants of the realignments throughout the European exchange rate mechanism (ERM). Motivated by the implications of optimising currency crisis models, we relate the probability of “crises” to a set of macroeconomic fundamentals. By using a conditional binominal logit model we show that regime switches are strongly influenced by movements in industrial production, foreign interest rates, competitiveness and imports as well as in foreign exchange reserves. These findings are consistent with the general propositions of recent currency crises models.     

Political Regimes and Currency Crises

This paper examines the relationship between political regime type and currency crises. Some theories suggest that democratic regimes, owing to their greater political transparency and larger number of veto players, should have a lower risk of currency crisis than dictatorships. Alternative arguments emphasize the advantages of political insulation and rulers with long time horizons, and imply that crises should be most likely in democracies and least common in monarchic dictatorships. We evaluate these competing arguments across four types of political regimes using a time‐series cross‐sectional dataset that covers 178 countries between 1973 and 2009. Our findings suggest that the risk of currency crisis is substantially lower in monarchies than in democracies and other types of dictatorship. Further analyses indicate that the adoption of prudent financial policies largely account for this robust negative association between monarchies and the probability of currency crises. This suggests that political regimes strongly influence financial stability, and perverse political incentives help explain why currency crises are so common.     

Exchange rate misalignments and the external balance under a pegged currency system

This paper analyzes the link between the exchange rate misalignments and the external balance under a pegged currency system focusing on the former French colonies of Africa (the CFA zone). Having discussed and chosen an appropriate analytical framework, it addresses the issue of model uncertainty regarding the equilibrium exchange rate model before estimating currency misalignments. The results show that misalignments have a negative and asymmetric impact on the current account. While overvaluation of the CFA franc deteriorates the current account, undervaluation does not improve it. Finally, our results highlight that the export concentration tends to exacerbate the overall negative impact of currency misalignments.     

Balance Sheet Effects, Growth, and Crises

This paper addresses two questions: are currency crises predicted by increases in a central bank’s external and contingent liabilities relative to assets, and do these “balance sheet effects” generate persistent output losses following a crisis? I find empirical evidence that the answer to both questions is yes. I use data on stocks of gross external assets and liabilities for 167 countries over 1973–2003, in an unbalanced panel probit regression to obtain robust estimates of the probability and determinants of a post‐crisis recession. Several single and simultaneous equation specifications support the idea that the output cost of a currency crisis depends on its transmission mechanism. Specifically, a recession is likely to be severe if it is preceded by a crisis that works its way through the financial sector. In addition, the results show that measures of contingent liabilities, capital flight, and lack of financial depth are significant predictors of costly crises.     

NEW ESTIMATION OF CHINA'S EXCHANGE RATE REGIME

Abstract. The present paper updates the question: what precisely is the exchange rate regime that China has put into place since 2005, when it announced a move away from the US dollar peg? Is it a basket anchor with the possibility of cumulatable daily appreciations, as was announced at the time? We apply to this question a new approach of estimating countries’ de facto exchange rate regimes, a synthesis of two techniques. One is a technique that has been used in the past to estimate implicit de facto currency weights when the hypothesis is a basket peg with little flexibility. The second is a technique used to estimate the de facto degree of exchange rate flexibility when the hypothesis is an anchor to the US dollar or some other single major currency. Because the RMB and many other currencies today purportedly follow variants of band‐basket‐crawl, it is important to have available a technique that can cover both dimensions, inferring weights and inferring flexibility. The synthesis adds a variable representing ‘exchange market pressure’ to the currency basket equation, whereby the degree of flexibility is estimated at the same time as the currency weights. This approach reveals that by mid‐2007, the RMB basket had switched a substantial part of the US dollar's weight onto the euro. The implication is that the appreciation of the RMB against the US dollar during this period was due to the appreciation of the euro against the dollar, not to any upward trend in the RMB relative to its basket.     

Liquidity and Twin Crises

This paper proposes a simple analytical framework for understanding 'twin crises'– i.e. crises where a currency crisis and banking crisis occur simultaneously and reinforce each other. The distinguishing feature of such crises is the spill‐over effects across financial institutions through collateral constraints, declines in market values of assets, currency mismatches on the balance sheet and the endogenous amplification of financial distress through asset sales. We explore the role of liquidity and the role of monetary policy in such crises. In particular, a central question is whether raising interest rates in the face of a twin crisis is the appropriate policy response. Raising interest rates has two countervailing effects. Holding the domestic currency becomes more attractive (other things being equal), but the value of the domestic banking system falls due to the fall in asset prices. When assets are marked to market, there is a potential for endogenously generated financial distress that leads to a collapse of asset prices, as well as the exchange rate. It is thus possible that raising interest rates can have the perverse effect of exacerbating both the currency crisis and the banking crisis.     

Explaining the Transition between Exchange Rate Regimes*

This paper studies the transition between exchange rate regimes using a Markov chain model with time‐varying transition probabilities. The probabilities are parameterized as nonlinear functions of variables suggested by the currency crisis and optimal currency area literature. Results using annual data indicate that inflation and, to a lesser extent, output growth and trade openness help explain the exchange rate regime transition dynamics.