The Economics of Exchange‐Rate Regimes: A Review Essay

The exchange‐rate regime issue has taken centre‐stage in discussions of international economic policy. Much of the profession appears to have been converted to ‘the hypothesis of the vanishing middle regime’; for countries well‐integrated into world capital markets, there is little, if any, middle ground between floating exchange rates and monetary unification. This paper considers the exchange‐rate‐regime issue in the context of recent books on the subject by W. Max Corden and Morris Goldstein. Both authors prescribe managed floating exchange rates, supplemented with inflation targeting, for emerging‐market economies. Under managed floating, and with a credible monetary policy, the public finances in order, and strengthened debt management and prudential regulation, the exchange rate is free to act as a market gauge for assessing policies and as a mode of conflict resolution. Both authors also argue, however, that no exchange‐rate regime is a Holy Grail. Ultimately, a credible exchange‐rate regime depends upon the trust evoked by governments. There is no exchange‐rate regime, whether of the managed‐floating or hard‐fix variety, that can eradicate a history of failed stabilisation attempts.     

Exchange rate risk under generalized floating: Eight Asian countries

This paper examines whether exchange rate risk (defined as the variability of nominal and real effective exchange rates) has increased in the present system of generalized floating for eight Asian developing countries. The first major finding is that the samples of effective exchange rates conform better to non-normal stable Paretian distributions than normal ones; sample standard deviation in therefore an erratic and misleading measure of variability. The second is that the scale and Gini's mean difference measures of variability indicate that exchange rate risk has increased substantially — in nominal terms more than in real terms and in the short run more than in the longer run.     

Currency mismatches and monetary policy: A tale of two equilibria

We develop a model of a small economy whose residents choose whether to borrow in domestic or foreign currency. The central bank, in turn, chooses fixed or flexible exchange rates, taking the currency denomination of debts as given. We characterize the simultaneous determination of portfolios and exchange rate regime. Both floating and fixed rates can occur as equilibrium outcomes. “Fear of floating” may emerge endogenously and in association with a currency mismatch in assets and liabilities. If equilibria with both fixed rates and floating rates coexist, the latter is Pareto superior. Lessons for current “de-dollarization” proposals are discussed.     

Flexible exchange rates and international trade: An empirical investigation of bilateral flows

This paper investigates the alleged adverse effect of floating exchange rates on international trade. A simple model is constructed to test the relationship between exchange rate variability and bilateral trade flows between the United States and three of its major trading partners: Canada, Japan and Germany. Using data from 1960 to 1983 to encompass both “stable” and floating rate regimes, it is shown that while exchange rate variability is considerably higher in the floating period, there is no evidence that this greater variability has had a negative impact on trade flows.     

从特别提款权看人民币汇率形成机制改革

根据特别提款权盯住一篮子货币的定值方法及其过去几年的汇率变化,人民币在汇率形成机制改革以后,对美元的浮动幅度会加大,而对欧元和日元的浮动幅度可能会减小.为此企业应该做好汇率风险防范、进行产品创新,适当增加欧元、日元等货币的使用,以化解人民币升值和人民币汇率形成机制改革的不利影响.     

Central Bank Intervention,Exchange Rate Regime and the Purchasing Power Parity

Motivated by the argument that central bank intervention leads to non‐linear exchange rate adjustment processes, we examine purchase power parity (PPP) by applying quantile unit root tests to the exchange rates of the New Taiwan Dollar (NTD) vis‐à‐vis seven Asian currencies. We show that exchange rate regime matters in determining whether PPP holds. While PPP holds overwhelmingly during the period when the NTD is under the fixed exchange rate regime, it is present only for some exchange rates during the managed floating rate regime. For exchange rates exhibiting mean reversion, the reversion occurs mainly when the shocks are large. In contrast to conclusion in the literature, our test results show little evidence of asymmetric mean reversion between positive and negative shocks.     

Consumption and real exchange rates in professional forecasts

Standard models of international risk sharing with complete asset markets predict a positive association between relative consumption growth and real exchange-rate depreciations across countries. The striking lack of evidence for this link — the consumption/real-exchange-rate anomaly or Backus–Smith puzzle — has prompted research on risk-sharing indicators with incomplete asset markets. That research generally implies that the association holds in forecasts, rather than realizations. Using professional forecasts for 28 countries for 1990–2010 we find no such association, whether for floating nominal exchange rate regimes, fixed exchange rates, or common currencies, thus deepening the puzzle.     

Exchange rate flexibility and the international liquidity “problem”

Contrary to the expectations of those who advocated flexible exchange rates prior to 1973, Williamson, in his study on exchange rate flexibility and reserve use, presented data which suggested “the paradoxical conclusion that reserve use actually increased following the adoption of floating”. As this finding was based on developments immediately after the final collapse of the Bretton Woods system in March 1973, there arises the question of whether it remains consistent with subsequent experience. Our author argues that the international liquidity “problem” has indeed not been resolved during the last decade and, proceeding from this conclusion, assesses its current implications.     

Floating exchange rates and their problems for the developing countries

The following article deals with the reasons for the fierce resistance of the developing countries to the system of floating exchange rates which the industrialized countries are favouring at present. It examines the consequences of floating exchange rates for the foreign trade, indebtedness and reserves of the developing countries and their implications for the situation in their domestic economies as a whole.     

The exchange regime and trade balance in Turkey

Over the last 15 years, high trade deficits have become a source of external vulnerability for the relatively stabilized Turkish economy. This corresponds to the period where authorities have been following a floating exchange rate regime. Thus, this study aims to empirically show whether the adopted exchange rate regime has an impact on the trade balance for the period of 1987 Q1 to 2015 Q2. Estimation results indicate that there is a long-run relationship between the real effective exchange rate and trade balance under both fixed and floating regimes in Turkey, but there is no evidence for the J-curve hypothesis.     

Currency distribution and forward cover in foreign trade: Sweden revisited, 1973

New data on currency distribution in Sweden's foreign trade payments for 1973 are presented and compared with data from an earlier survey for 1968. The basic pattern remains unchanged, invoicing being predominantly made in local currencies. The limited use of U.S. dollars, and other third-country currencies, has remained approximately the same over the five-year period, though with a marked shift from pounds to dollars and D-marks. Both the 1968 year of fixed parities and the 1973 year of floating exchange rates display a symmetric payments system, without any particular currency playing the role of ‘international money’ in private transactions. Data are also supplied for the total volume of forward transactions in Sweden from 1966–1974. As anticipated in foreign exchange theory, forward covering of trade payments has increased sharply since the floating of exchange rates in 1973.     

Purchasing power parity under fixed and flexible exchange rates

The relationship between exchange rates and relative price levels in a sample of fourteen countries is studied for periods of fixed and of floating exchange rates. In comparing the deviations of the exchange rates from their purchasing power parity levels in the two cases it turns out that both the average size of the divergencies and their duration are smaller under the fixed rate period 1957–1966 than under the recent period of floating rates. The adjustable beg years of the late sixties fall in between. Evidence is also found which indicates a bias in purchasing power parity calculations using consumer price indexes, and the hypothesis that purchasing power parity relationships shifted as a result of changes in relative prices occuring at the end of 1973 cannot be rejected. The findings are related to the empirical literature on the international transmission of inflation and to recent comparisons of exchange rates and relative inflation rates.     

Currency risk cover — an enquiry among German firms

Intereconomics - The attitude of German exporters and importers to currency risks under a system of floating exchange rates has, for the first time, been the subject of an empirical study by the...     

Commodity currencies

This paper looks at real exchange rate behavior by focusing on three OECD economies (Australia, Canada, and New Zealand) where primary commodities constitute a significant share of their exports. For Australia and New Zealand especially, we find that the US dollar price of their commodity exports (generally exogenous to these small economies) has a strong and stable influence on their floating real rates, with the magnitude of the effects consistent with predictions of standard theoretical models. However, after controlling for commodity price shocks, there is still a purchasing power parity puzzle in the residual. The results here are relevant to developing commodity-exporting countries as they liberalize their capital markets and move towards floating exchange rates.     

Policy dialogue between multilateral institutions and developing countries

The lending criteria applied by the IMF and the World Bank have been converging for some time. Considering also that since the floating of exchange rates in the early seventies the IMF seems to have lost in importance as a monetary institution, debate is growing on the question of whether the Fund needs to correct its policy course, to be assigned new tasks by its member countries or even to be amalgamated with the World Bank into one efficient development aid institution.     

Speculative behavior of foreign exchange rates during the current float

The current regime of floating exchange rates has been characterized by a number of informed observers as economically unsatisfactory. Use of terms such as “overshooting”, “bandwagon effects”, “destabilizing”, and “insufficient speculation” reflects serious misgivings on the part of many toward the long-run viability of a floating, rather than a fixed or semi-fixed, rate regime. Using fairly standard procedures, the authors have attempted to determine the extent to which the foreign exchange market exhibits the adverse features noted above. The authors conclude that by and large foreign exchange markets have not performed particularly poorly. The foreign exchange markets seem to be efficient at least in the weak form sense. Past exchange rate changes are not useful in predicting future exchange rate changes. This empirical finding contrasts sharply with the view that the markets “overshoot”, or that there are “bandwagon effects”, or that the amount of price stabilizing speculation is inadequate.     

International trade in a system of floating exchange rates

Since the introduction of the system of floating exchange rates policy-makers have been troubled by uncertainties regarding the effects of this system on international trade. Do exchange rate changes affect trade flows? Can governments manipulate exchange rates? Have countries been “injured” by exchange rate changes? What are the real costs of international monetary instability? Answers to these key questions are given in the following article.     

An examination of foreign exchange risk under fixed and floating rate regimes

This paper examines variability risk in foreign exchange markets during fixed and floating rate regimes. It is demonstrated that variance is an inadequate measure of variability, both theoretically and empirically. Although the normal model is commonly employed in foreign exchange research, the paper shows that spot and forward rate changes can be better described as if they were generated from nonnormal members of the Pareto-Levy class of probability distributions. Further, the paper discusses what statistical measures of variability are most appropriate. Several measures are developed to assess the characteristics of spot and forward rate changes during the period 1962–1975. It is found that floating rates are generally many times riskier, in the variability sense, than fixed rates.     

Methods of assessing the long-run equilibrium value of an exchange rate

The many industrial countries which have in recent years opted for a managed floating exchange rate regime are now in need of methods for assessing the appropriateness of their exchange rates and for guiding their exchange rate management policies. Three methods are considered here: the purchasing power parity (PPP) method, the underlying payments disequilibria (UPD) approach, and the asset-market disturbances (AMD) method. All three methods are found to have serious weaknesses, but, if used with care, provide rough yardsticks that would help the authorities in preventing their exchange rates from becoming widely undervalued or overvalued.