Understanding Exchange Rate Regimes and Classifications

Exchange Rate Regimes Andrew K. Rose Visiting Norman-Houblon Fellow August, 2010 1

Three Questions Past: What do We Know about Exchange Rate Regimes Historically? Rose Fixed, Floating and Flaky Present: How did Different Exchange Rate Regimes do in the Great Recession ? Rose and Spiegel Causes and Consequences Future: What are the Expected Effects of China s Switch in Regime? Eichengreen and Rose 27 Up 2

Past: A Stylized Description of Exchange Rate Regime 3

Exchange Rate Classifications Bad Old Days: IMF used official policy But De Jure Systems of Exchange Rate Classification do not Cohere well with Actual De Facto Behavior 4

3 Popular(Newish) De Facto Classifications Levy-Yeyati and Sturzenegger Cluster Analysis on Exchange Rates and Reserves Reinhart and Rogoff Black Market Rates Shambaugh Nominal exchange rate movements 5

Poor Coherence IMF Levy-Yeyati & Sturzenegger Reinhart & Rogoff Shambaugh IMF Levy-Yeyati & Sturzenegger Reinhart & Rogoff Shambaugh 100% 59% 100% 59% 55% 100% 68% 65% 65% 100% 6

Message Don t rely on any single system! 7

Some Stylized Facts 8

Many Countries are Fixed Exchange Rate Regimes over Time Distribution of Countries by Regime IMF De Jure Levy-Yeyati & Sturzenegger 100% 100% Float Float Intermediate Intermediate 50% 50% Fix Fix 0 0 1970 1980 1990 2000 2010 1970 1980 1990 2000 2010 Shambaugh Reinhart & Rogoff 100% 100% Float Non-Peg Intermediate 50% 50% Peg Fix 0 0 1970 1980 1990 2000 2010 1970 1980 1990 2000 2010 9

Not Much GDP in Fixers Exchange Rate Regimes over Time Distribution of GDP by Currency Regime IMF De Jure Levy-Yeyati & Sturzenegger 100% 100% Float Float 50% 50% Intermediate Intermediate Fix Fix 0 0 1970 1980 1990 2000 2010 1970 1980 1990 2000 2010 Shambaugh Reinhart & Rogoff 100% 100% Float Non-Peg 50% 50% Intermediate Peg Fix 0 0 1970 1980 1990 2000 2010 1970 1980 1990 2000 2010 10

Regimes are Becoming Durable Exchange Rate Regime Switches over Time Proportion of Global GDP in Economies with Changing Regimes IMF De Jure Levy-Yeyati & Sturzenegger .6 .6 .4 .4 .2 .2 0 0 1970 1980 1990 2000 2010 1970 1980 1990 2000 2010 Shambaugh Reinhart & Rogoff .6 .6 .4 .4 .2 .2 0 0 1970 1980 1990 2000 2010 1970 1980 1990 2000 2010 11

Does Size (Population) Matter? Many fixers are small. But: many small economies Berkeley California has population > 49 (/237 ) countries and other entities in CIA s World Factbook Many included in the various exchange rate classifications No doubt that smallest economies of the world do not float Many don t have own currencies 95 of CIA s listed countries do not have national currency Easy to overstate; countries do not have to be large before creating a floating currency Small floats include: the Seychelles (population 88,000 in June 2010), Tonga (123,000), and Sao Tome and Principe (176,000). 12

Quantile Plots of Size Size of Fixers and non-Fixers Quantile Plots of logs 2004 PWT 6.3 Population Official IMF Levy-Yeyati & Sturzenegger 14 14 Fix Fix 9 9 4 4 4 9 14 4 9 14 non-Fix non-Fix Shambaugh Reinhart & Rogoff 14 14 Fix Fix 9 9 4 4 4 9 14 4 9 14 non-Fix non-Fix 13

So Size Matters only at the tail Size Matters much less at 2.5 million 135 countries Size Matters not at all beyond 10 million 75 countries 14

Income? No Effect Income of Fixers and non-Fixers Quantile Plots of log 2004 PWT 6.3 Real GDP per capita Official IMF Levy-Yeyati & Sturzenegger 10 11 10 11 9 9 Fix Fix 8 8 7 7 6 6 6 7 8 9 10 11 7 8 9 10 11 non-Fix non-Fix Shambaugh Reinhart & Rogoff 10 11 10 11 9 9 Fix Fix 7 8 8 7 6 6 6 7 8 9 10 11 6 7 8 9 10 11 non-Fix non-Fix 15

Other Stylized Facts, 1 1. Two Anchors Dollar (66 fixers); Euro (227) 2. All Large Rich Economies Float Large: Dollar, Yen, Euro, Medium: UK, Canada, Australia, Switzerland, EMs: Brazil, India, Indonesia, Korea, Mexico, Russia, and Turkey China is exception 16

Other Stylized Facts, 2 3. Regions Differ Sub-Saharan Africans fix Central Europeans, Asians do not 4. Oil Exporters Fix Especially OPEC members in Gulf 17

Other Stylized Facts, 3 5. Small Financial Centers Fix Mostly Small 6. Inflation Targeters Float Often Very Cleanly 7. Nominal Exchange Rate Volatility is Real Mussa 18

Causes of Exchange Rate Regime Theory #1: Sources of Shocks Countries with real shocks should float Financial shocks implies fix Stockman (2000) the evidence supporting the predictions of these models is only slightly better than the evidence for cold nuclear fusion 19

Another Theory: Credibility Fixed nominal exchange rate transparent easily monitored monetary anchor Import credibility by fixing to Fed/Buba Tornell and Velasco: fiscal indiscipline eventually undermines most fixes Float: easier to monitor, faster punishment, better discipline So credibility arguments theoretically ambiguous Is exchange rate constraint different from other constraints (e.g., Inflation Targeting)? 20

Microeconomic Arguments Facilitate Trade Size? Possible if Hedging Risk difficult (LDCs) Deepen Micro-Structure of FX market? Deepen liquidity But many rich countries (Denmark, HK) fix Little intervention outside FX (stocks, bonds) 21

Shameful Empirics No Time-Series Understanding OK since most determinants sluggish No Cross-Country Success Either Very small countries, autocracies , former colonies, financial centers, oil exporters fix Little of the cross-country variation explained though An Embarrassment! Almost no covariates of exchange rate regime choices empirically. 22

What about Consequences? 23

Growth Consequences of Regimes? Classification Official IMF Narrow Crawl .8* (.3) -.3 (.4) Wide Crawl .5 (.4) -1.0* (.5) Float .2 (.5) .5 (1.2) Falling Reinhart and Rogoff -4.3** (.6) Intermediate Float Levy-Yeyati and Sturzenegger -1.5** (.4) -.5 (.4) Non-Peg Shambaugh .3 (.3) 24

Inflation Consequences of Regimes? Classification Official IMF Narrow Crawl -9.1** (2.1) .4 (2.4) Wide Crawl 2.7 (3.6) .8 (3.1) Float 8.8 (6.3) 7.9 (4.3) Falling Reinhart and Rogoff 62.** (9.6) Intermediate Float Levy-Yeyati and Sturzenegger 18.4** (3.1) 3.5 (1.9) Non-Peg 7.3** (1.8) Shambaugh 25

Quick Summary of Consequences No Real Growth Effects Reasonable; monetary neutrality Unclear Inflationary Consequences Also: no effect on volatility Baxter-Stockman (1989); Flood-Rose (1995); Obstfled-Rogoff Six Puzzles (2001) 26

Is this Question Worth Asking? Countries with similar income, size, openness, institutions choose different regimes: Singapore vs. Hong Kong Denmark vs. Sweden vs. Finland Costa Rica vs. Panama No convergence, few apparent causes, no clear consequences 27

Exchange Rate Regimes are Flaky Caring about exchange rate regimes is akin to caring about individual preferences for wine or beer 28

Present: The Non-Effect of Exchange Rate Regimes on Crisis Incidence 29

Cross-Country Approach to Great Recession Use cross-section of (107) countries to ask which countries experienced biggest crises A necessary (but far from sufficient) part of any successful early warning system Cross-sectional questions easier than time-series modeling Attempt to link (2006 and earlier) crisis causes to (2008 and later) crisis consequences 30

Rose-Spiegel (2010a,b,c) Findings Great Recession progressive; countries with higher income suffer worse crises (as in RS) No other robust results Over 80 national causes/vulnerabilities Over 40 international linkages 31

Cross-Sectional Data Set All countries/territories with real GDP per capita at least $10,000 in 2003 All countries/territories with real GDP per capita at least $4,000 in 2003 and population at least 1 million 32

Emerging Literature Four Big Differences from RS Measures of Crisis Intensity Potential Causes (Covariates) Estimator linking causes, intensity Country Sample 33

Key References Berkmen, Gelos, Rennhack, Walsh (2009) BGRW Blanchard, Faruqee and Das (2010) BFD Claessens, Dell Arriccia, Igan, Laeven (2010) CDIL Frankel and Saravelos (2010) FS Giannone, Lenza and Reichlin (2010) GLR Lane and Milesi-Fettetti (2010) LMF 34

Measures of Crisis Intensity (Dependent Variables) 1. Default: Real 2008-09 GDP growth (from EIU) 2. Real GDP growth change, 2008-09 - 2005-07 (LMF) 3. Real GDP growth change, 2008-09 - 1990-07 (BFD) 4. Revision to WEO 2009 growth forecast (BGRW) 5. 2009 output gap (from OECD) 6. 2008-09 consumption growth 7. First Principal Factor from 4 RS variables 35

Modeling Crisis Causes (Regressors): Many Unsuccessful Attempts Credit %GDP Debt %GDP Domestic Banking Sector Characteristics Fiscal Policy Trade Flows Capital Flows 36

Causes: Some Successes (RS Investigate All) Fixed Exchange Rate Regime (BFD, LMF) House Price Appreciation (CDIL) Credit Growth (BGRW, CDIL, LMF) Credit Market Regulation (GLR) Current Account %GDP (CDIL, LMF) Financial Leverage (BGRW) Reserves (FS, Obstfeld et al for depreciation) Short-Term External Debt (BGRW) Trading Partner Growth (BFD, LMF) 37

Different Country Samples Full sample (107) (51) World Bank High Income (74) IMF non-Advanced (89) non-Oil Exporters (91) non-Small Financial Centers (51) non-oil, non-FC High/Upper-Middle Income 38

Simple Econometrics LS cross-country regressions, White se s Condition on log (2006) real GDP per capita Add dummy for 2006 fixers Different regressands, samples 39

Effect of Exchange Rate Regime (Dummy for 2006 Fix) All High Income .51 (1.92) -.25 (1.72) -.60 (1.81) 1.15 (.98) -.62 (.70) 3.46 (4.64) .01 (.21) No Adv. -1.79 (1.91) -2.50 (1.99) -2.48 (1.95) -.13 (.91) n/a No Oil No Fin l Centers -1.62 (1.55) -2.42 (1.60) -2.38 (1.56) -.29 (.73) -.55 (.78) .38 (2.62) -.22 (.17) No Poor, Oil, FCs -2.29 (2.01) -3.54 (2.24) -2.76 (2.10) -1.10 (.95) -.55 (.78) -1.86 (1.39) -.21 (.22) 2008-09 Growth 2008-09 Grow - 05- 07 Grow 2008-09 Grow - 90- 07 Grow Revised WEO 09 Grow Fost Output Gap 2009 Cons. Growth 2008-09 Extracted Prin. Factor -1.42 (1.41) -2.11 (1.46) -2.08 (1.42) .16 (.72) -.73 (.71) .36 (2.39) -.14 (.17) -3.07* (1.48) -3.21 (1.62) -2.96 (1.53) -.39 (.80) -.73 (.71) -1.47 (1.13) -.26 (.18) -1.06 (2.73) -.17 (.24) 40

Note Insignificant Effects! Fixed Exchange Rate Regimes almost never significantly affect growth Signs mostly negative (5/41 positive) Very weak indications of importance 41

True of Other Covariates Too! Very difficult to link cross-country crisis incidence of causes and consequences of Great Recession 42

Future: What Can We Expect from China s Switch? 43

Chinese Exit from Peg: June 19 2010 What can We Expect? Are there any Precedents? Most departures from fixes occur under periods of duress Accordingly, depreciation expected Modeled by Krugman and others 44

27 Precedents Use Reinhart-Rogoff monthly system of 15 exchange regime classifications China: pegged initially Moves to More Flexible Regime Appreciates 27 other observations of regime switch (fix to more flexible) and appreciation ($ or SDR) 45

The 27 Episodes Austria, 1971 Canada, 1970 Denmark, 1971 Eq. Guinea, 1979 Finland,1973 France, 1971 Germany, 1969 Germany, 1971 Germany, 1973 Hong Kong, 1972 Netherlands, 1971 Japan, 1973 Libya, 1971 Malaysia, 2005 Malta, 1972 Mauritania, 1974 Mozamb., 2004 S.Africa, 1972 Spain, 1974 Sweden, 1973 Switzerland, 1973 Tunisia, 1974 UK, 1972 NZ, 1973 Nigeria, 1971 Portugal, 1973 Singapore, 1973 46

Growth around Appreciating Exits Annual Growth around (27) Fix Exits with Appreciation 30 20 10 0 -10 -20 -5 0 5 47

Little Happens to Growth Some heterogeneity Still, no reason to expect big changes What about the macro-economy in general? 48

The Macroeconomy 20 30 40 20 10 30 10 0 20 0 -10 10 -10 -5 0 5 -5 0 5 -5 0 5 Real GDP growth Investment/GDP Inflation 200 40 20 100 20 0 0 0 -20 -100 -20 -40 -5 0 5 -5 0 5 -5 0 5 Trade/GDP Export Growth Current Account/GDP 100 100 3 2 50 50 1 0 0 0 -1 -50 -50 -5 0 5 -5 0 5 -5 0 5 Domestic Credit Growth M2 Growth Reserves/M2 Means and +/-2se CI; Chinese post-'99 means shown Annual Movements around (27) Fix Exits with Appreciation 49

International Reserves .8 1.5 .6 1 .4 .5 .2 0 0 -5 0 5 -5 0 5 Reserves/GDP ST Debt/Reserves 3 15 2 10 1 5 0 0 -5 0 5 -5 0 5 Reserves/Import Months Reserves/M2 Means and 90%CI; Chinese post-'99 means shown Annual Movements around (27) Fix Exits with Appreciation 50