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Summary Weeks 1-3 Frieden et al. Politics and exchange rates- a cross country approach
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A summary and note page of the important points from the readings
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Determinants of the choice of Regime:-Latin America 1990s trying to gain credibility for anti-inflation policies by fixing to a nominal
anchor currency.
-problem with this is it assumes benevolent government social welfare maximizing, no
consensus on welfare criteria for exchange rate regimes, such an idea is also hard to justify in
theoretical and empirical grounds.
-focus on exchange rate policy as any other form of political policy.
-Some studies find weaker govs (governments) and unstable political environments reduce
likelihood that peg will be adopted.
Exchange rate arrangement:
-do not choose regimes for the regimes, diff regimes produce diff outcomes.
-countries choose based off these trade-offs: credibility, flexibility and stability
-govs may adopt fixed policy for credibility to fight inflation. Fixed may also provide stability of
both nominal and real exchange rates (ERs)
-fixed rates may cost flexibility, cannot use policy to react to shocks
-with fixed an inflation differential between pegging country and the anchor generates an
appreciation of the real exchange rate that, in the absence of compensating productivity gains,
hurts the tradeables sector and might generate a balance of payments crisis.
-High inflation countries way want to adopt fixed rates but this will cause competitive pressures
on tradeables producers and the balance of payments.
Classifications of distinctions of regimes:
1.Pegged to single currency 2. pegged to basket of currencies 3. pegged with frequent
adjustments (sustained less than 6 months 4. forward-looking crawling pegs (such as
tablitas) 5. forward-looking crawling bands 6. backward-looking crawling pegs 7.
backward-looking crawling bands 8. managed floats 9. free floating
-fixed regime was associated with lowest inflation. Forward-looking regime is usually only used
when inflation is high enough that peg is unsustainable.
-fixed may not necessarily cost competitiveness, small and very open economies with low
inflation. Concentrated trade like most Caribbean countries may choose fixed for stability
without such competitive costs.
-crawling pegs like tablitas are for bringing inflation under control and since exchange rate is
used as nominal anchor for inflation it comes at cost of appreciation of real exchange rate and
thus loss of competitiveness.
-backwards-looking regimes other extreme side of trade-off, associated with highest
depreciation. This may occur under flexible regimes because sometimes implemented right after
balance of payments crisis following an appreciated ER. Backwards looking usually put in place
when ER is already depreciated in order to keep its level competitive.
Potential determinants of exchange rate regimes:
Macroeconomic, external and structural variables
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