Summary
Under the Bretton Woods system that prevailed until the early 1970s, nearly all countries pegged their exchange rate to the US dollar. The breakdown of this system led an increasing number of countries to adopt some form of floating exchange rate. This trend towards increased exchange rate flexibility stopped around 1990, although it has not actually been significantly reversed.
In this Nottingham School of Economics working paper Michael Bleaney and co-authors model the factors determining the choice of exchange rate regime. A peg is more likely to be chosen if a country is small, poor, and has low inflation and a high ratio of international trade to GDP. Since 1990 lower inflation has been a significant factor working in favour of pegged exchange rates, and this has masked a continuing shift in preferences in the direction of greater flexibility. There is not universal agreement on identifying exchange rate regimes, so four different classification schemes are examined. A binary classification is used: the regime in any particular country in a given year is either a peg or a float. All four classification schemes identify an increasing proportion of floats up to 1990, but since 1990 this trend has ceased (and even been reversed according to one scheme). An optimum currency area model of the choice of exchange rate regime is estimated. When a time trend is added to this model, it is possible to separate trends in the dependent variable into (a) trends in the explanatory variables and (b) trends in underlying preferences (i.e. for given values of the explanatory variables). A significant shift in preferences towards floating is evident before 1990 and, according to three out of the four classification schemes, after 1990 also. According to the model, this trend has not been reflected in an increased popularity of floating since 1990 principally because reductions in global inflation rates have induced an offsetting shift towards pegs.
Download the paper in PDF format
School Discussion Paper 2015-03, Global Trends in the Choice of Exchange Rate Regime by Michael Bleaney, Mo Tian and Lin Yin
Authors
Michael Bleaney, Mo Tian and Lin Yin
View all School of Economics discussion papers | View all School of Economics featured discussion papers
Posted on Sunday 1st March 2015