Do Exchange Rate Regimes Matter? Evidence for Developing Countries

Larrain, Felipe and Parro, Francisco (2006): Do Exchange Rate Regimes Matter? Evidence for Developing Countries.

Abstract

Most countries which have experienced exchange rate crises over the last two decades have been under soft pegs or crawls. These exchange rate arrangements have normally succumbed in the face of massive capital inflow reversals --especially in developing countries-- thus provoking a search for options. Hard pegs and floating regimes seem to be the only viable options. This paper carries through an empirical analysis with panel data to study the relationship between the option of exchange rate regime and macroeconomic performance in developing countries. We use an extended and updated database to study the evidence for 154 countries over the period 1974-2004. Performance is measured by per capita GDP growth and its volatility. Our results show that floating rates tend to present higher levels of growth and lower levels of volatility in relation to other exchange rate arrangements. Intermediate regimes (soft and crawling pegs), on the other hand, score at the bottom of the growth rankings, while hard pegs appear to induce the largest growth volatility. In light of these results, it should not come as a surprise that the world is not moving to a single global currency, as some have predicted. The world is moving to fewer currencies, but at an extremely slow pace. Yet, floating rates will probably remain the most popular form of exchange rate regime over the next half century. This paper provides some basis for that popularity.

• Item Type: MPRA Paper
• Language: English
• Keywords: exchange rate regimes, hard pegs, developing countries, growth regressions, volatility
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C13 - Estimation: General; O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O47 - Empirical Studies of Economic Growth ; Aggregate Productivity ; Cross-Country Output Convergence; C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C23 - Panel Data Models ; Spatio-temporal Models; O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O40 - General; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

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