Working Paper: NBER ID: w12729
Authors: Michael W. Klein; Jay C. Shambaugh
Abstract: The impermanence of fixed exchange rates has become a stylized fact in international finance. The combination of a view that pegs do not really peg with the "fear of floating" view that floats do not really float generates the conclusion that exchange rate regimes are, in practice, unimportant for the behavior of the exchange rate. This is consistent with evidence on the irrelevance of a country's choice of exchange rate regime for general macroeconomic performance. Recently, though, more studies have shown the exchange rate regime does matter in some contexts. In this paper, we attempt to reconcile the perception that fixed exchange rates are only a "mirage" with the recent research showing the effects of fixed exchange rates on trade, monetary autonomy, and growth. First we demonstrate that, while pegs frequently break, many do last and those that break tend to reform, so a fixed exchange rate today is a good predictor that one will exist in the future. Second, we study the exchange rate effect of fixed exchange rates. Fixed exchange rates exhibit greater bilateral exchange rate stability today and in the future. Pegs also display somewhat lower multilateral volatility.
Keywords: exchange rate regimes; fixed exchange rates; floating exchange rates; bilateral stability; multilateral stability
JEL Codes: F33; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fixed exchange rates (F31) | greater bilateral exchange rate stability (F31) |
| fixed exchange rates (F31) | lower bilateral volatility in the future (E32) |
| duration of a peg (C41) | future stability of the peg (F31) |
| fixed exchange rates (F31) | increased bilateral trade (F10) |
| first year of a peg (Y20) | higher volatility (G17) |