1. Choice of Exchange
Rate Regime

2. Outline
• Types of exchange rate regimes
• Intro the different articles
• Disadvantages of fixed and intermediate exchange rate regimes
• Advantages of fixed
• Bipolar view
• Advantages of intermediate exchange rate regimes
• Conclusion
• China case study

3. Types of exchange rate
regimes
• Fixed
• Currency boards, union, dollarization
• Floating
• Managed float, free float
• Intermediate
• Crawling, target zone

4. The Mirage of Fixed Exchange
Rates - Obstfeld & Rogoff (1995)
• Both fixed and intermediate exchange rates are not viable in the
long run
• Speculative attacks also might happen to hard pegged currencies
• Hong Kong
• Problems with defending a peg:
• High interest rates
• Overvaluation
• Not an issue of feasibility but credibility (next slide for table)
• Can the government stand by exchange rate and tolerate other
macro-economic problems?

6. Table 1
Foreign Exchange Reserves Compared with the Monetary Base, September 1994
{percentages of GNP)
Monetary base Nongold reserves ToUU reserves
Belgium 6.7 7.2 12.1
Denmark 8.6 7.4 8.1
Finland 11.2 9.7 10.4
France 4.6 1.9 4.6
Germany 9.9 4.3 6.2
Ireland 9.1 15.8 16.1
Italy 11.9 3.0 5.6
Mexico 3.9 4.6 4.7
Netberlands 10.0 9.6 13.6
Norway 6.3 18.3 18.7
Portugal 25.0 19.9 28.0
Spain 12.6 8.3 9.6
Sweden 13.0 10.9 12.1
United Kingdom 3.7 3.6 4.3
j.-Total foreign exchange reserves include gold valued at $395.35 per ounce (September 1994 price).
Reserves include Special Drawing Rights at IMF. Reserves placed with the European Monetary Instilute
by EMS members are not counted in total reserves, but member ECU holdings are. Belgium's base is
for the fourth quarter of 1992, the U.K-'s for the first qtiarter of 1994. CINP is annual 1994 figure except
for Finland, Spain and Sweden, which report GDP. 1993 GNP for Belgium, Denmark, France, Ireland
and Mexico. 1992 GNP for Ponugal. 1992 GDP for Italy.
Sour€ e:MF, International Financial Statistics, May 1995.
down a speculative attack of any magnitude, provided they are willing to subordinate
all the other goals of monetary policy. To defend a currency peg, the monetary

7. Exchange Rate Regimes: Is the Bipolar
View Correct? - Stanley Fischer (2001)
Move away from soft pegs
Why?

8. Exchange Rate Regimes: Is the Bipolar
View Correct? - Stanley Fischer (2001)
• “the intent of the bipolar view is not to rule out everything but
the two corners, but rather to pronounce as unsustainable a
segment of that line representing a variety of soft pegging
exchange rate arrangements”
• Collapses of pegged rate regimes (similar arguments to ones
posed earlier)
• Countries open to international capital flows and with a fixed
exchange rate still try to have a monetary policy directed at
domestic goals
fixed exchange
rates
financial monetary
openness independence

9. Exchange Rate Regimes: Is the Bipolar
View Correct? - Stanley Fischer (2001)
If the country runs a BOP
deficit, it is losing reserves
continuously over time, which it
cannot do indefinitely.
i LM
LM'
E
i* BP
A
IS
0 Y

10. Exchange Rate Regimes: Is the Bipolar
View Correct? - Stanley Fischer (2001)
• Advantages of hard peg
• Argues that currency boards have proven to be strong
(though with some disadvantages)
• Anchor for disinflation
• Monetary stability
• Advantages of floating exchange rates
• Allow country to retain monetary independence
• Flexibility of exchange rates allows quick adjustments to
trade shocks
• Hence the bipolar view

11. Currency boards
• No adjustment via nominal exchange rate
• But means of price stability
• Gains in capital markets
• No lender of last resort
• But can be compensated with fiscal resources

12. The Evolution of Thought on Intermediate
Exchange Rate Regimes – John Williamson (2002)
• Floating exchange rates are not only determined by economic
fundamentals and interest rates but are driven by fads and bubbles.
(Meese and Rogoff 1983)
• A floating rate does not provide a basis for fast export-led growth
• The possibility of an intermediate regime which minimizes the risk of
speculative crises
• Advantages that intermediate regimes may offer:
• Greater transparency
• Stabilize speculation
• Platform for regional monetary collaboration
• Author, while acknowledging the ideal possibility of such arrangements,
concedes it is not so possible

13. Choice of Exchange Rate Regime
• The spectrum of exchange rate regimes has their merits and drawbacks.
The choice of exchange rate regime depends on the nature of the country
itself; its history, economic development and environment.
• Hard Peg:
• Countries with history of monetary instability
• Countries closely integrated with another country or group of
economies
• Floating:
• Countries with the belief that a flexible exchange rate helps their
economy adjust to the type of macroeconomic shocks it experiences

14. On the Yuan: The choice between adjustment under a
fixed exchange rate and adjustment under a flexible
rate - Jeffrey Frankel (2006)
• Background
• Two independent policy measures (next slide)
• No expenditure reducing policy (exchange rate)
• Real appreciation through high inflation in China RER = EP ∗ /P
• Low risk of currency crisis
• Loads of foreign reserves, running BP surplus
• US treasury securities do not pay a high return
• Harder to sterilize as you shove more bonds to the Chinese people
• Balassa-Samuelson relationship and regressions suggest that Chinese
yuan should appreciate in real terms by more than 4% a year.

15. Internal
Overheating balance
Surplus
C2002
(Price of foreign
exchange)
Recession
Deficit
External
balance
i (interest rate) or other expenditure-reducing policy

16. Balassa-Samuelson
relationship
• Prices of non-traded goods, and
thereby of general price levels, rise
with levels of productivity, real wages
and real income.
• Regression of q (log of real exchange
rate) against y (log of real GDP per
capita)
RER = EP /P∗

17. Discussion