What Is an Exchange Rate Regime?

The exchange rate system is also known as the Exchange Rate Arrangement: refers to the system regulations made by countries or the international community on the principles, methods, methods and institutions for determining, maintaining, adjusting and managing exchange rates. Traditionally, according to the magnitude of exchange rate changes, exchange rate systems have been divided into two types: fixed exchange rate systems and floating exchange rate systems. Western countries implemented fixed exchange rates before the 1970s. Later, due to the dollar crisis, the Bretton Woods system collapsed, and countries began to adopt floating exchange rates.

Exchange Rate System

According to an analysis by the IMF's World Economic Outlook in May 1997, the following factors should be considered when choosing an exchange rate system:

First, economic scale and openness. If trade accounts for a large share of GNP, the cost of currency instability will be high, and a fixed exchange rate system is best.

Second, the inflation rate. If the inflation rate of a country is higher than that of its trading partners, its exchange rate must float to prevent the competitiveness of its goods from falling in the international market. If the difference in inflation is modest, it is better to choose a fixed exchange rate system.

Third, labor market elasticity. The more rigid wages, the more it is necessary to choose a floating exchange rate system, so that the economy can better respond to external shocks.

Fourth, the degree of financial market development. In developing countries with immature financial markets, it is unwise to choose a free-floating system, because a small amount of foreign currency transactions will cause severe market turbulence.

Fifth, the credibility of policymakers. The worse the popularity of the central bank, the

Overview of the exchange rate system

Emerging market countries, that is, developing countries with open capital markets or highly open countries, and countries with economies in transition, which exchange rate system should be chosen, and what lessons should be learned from the crises that have occurred in recent years, which have become hot topics for discussion in the academic community. . This discussion focused on the disappearance of the middle system. The theoretical point of view is that the exchange rate system is nothing more than a choice between the two poles-the currency bureau system or the currency union and the floating exchange rate system with only moderate and smooth intervention. Only these two extreme exchange rate systems are sustainable. The exchange rate system in between and the adjustable pegged exchange rate system are at least unreputable for emerging countries. The intermediate exchange rate system is disappearing or has disappeared.

The theory of the disappearance of the intermediate system holds that under the condition of high-speed capital flow, the government's commitment to the exchange rate has become increasingly fragile, and the soft-pegged exchange rate system is unsustainable. There are three main points in favor of the intermediate exchange rate system.

(1) Trilemma. The explanation of the intermediate exchange rate system started from the traditional Fleming Mundell model. According to Summers, the trilemma of free capital flow, independent monetary policy, and fixed exchange rates illustrates that a country can only choose two of three goals. Under the circumstances that high-speed capital flows have become an established premise, a country can only make two choices: an independent monetary policy and a floating exchange rate system; abandoning the independence of monetary policy and adopting a fixed exchange rate system. So this determines that the government can only choose in the bipolar exchange rate system. But Frankel pointed out that no exchange rate system will be suitable for all countries and all periods of a country. The choice of the system should depend on the specific characteristics of each country. He believes that why not give up half of the two goals and half the stability of the exchange rate , The independence of half of monetary policy? That is, an intermediate exchange rate system can exist. More importantly, Frankel believes that the hypothesis of corner solutions lacks a theoretical basis.

(2) Banks have accumulated excessive debt. Eichengreen used to explain the hypothesis of corner solutions. He believes that under the pegged exchange rate system, banks and businesses will underestimate the risk of currency decline or collapse, and will therefore excessively hold unwritten off foreign currency debt. When the currency depreciates, its domestic currency income is not enough to pay off these debts, so it goes bankrupt and has a devastating effect on the economy. So he believes that in the case of high capital flows, there are only two feasible exchange rate policies, one is to fix the exchange rate and lock it, such as Argentina; the other more common exchange rate policy is to let its currency float, so that banks And companies will have an incentive to write off foreign exchange risks. This analysis is based on the irrationality of businesses and banks, and increases the risk of foreign exchange by deliberately creating uncertainty.

(3) Policy inertia. Another interpretation of the intermediate exchange rate system is that government-implemented policies often have inertia. When a government implements a pegged exchange rate and finds problems, it always waits for a long time to adjust the exchange rate for political reasons, or to change the exchange rate system. The government is always thinking whether it is necessary to make adjustments and stick to it. When the problems accumulate and have to be adjusted, it is too late and the losses are huge. The solution is to move to a hard-pegged exchange rate system or persuade the government to adjust the exchange rate as soon as possible.

Analysis of the disappearance theory of exchange rate system

The above explanation of the intermediate exchange rate system is not convincing. Some scholars began to use Verifiability to construct the theoretical basis of the vanishing theory of the intermediate exchange rate system. The intermediate exchange rate system is essentially under the control of the government, which makes the exchange rate fluctuate within a larger or smaller range. The formation of a currency union (such as the European Union) assumed by the corner point solution is through extremely complicated political procedures, and the fixed exchange rate system under the currency bureau system is also made into law through legislative procedures. Similarly, abandoning them can only be achieved through complex political decision-making processes and through bargaining between stakeholders. Therefore, the corner point system is much more expensive for the government to change the exchange rate than the intermediate exchange rate system. Moreover, the transparency of the rules is obviously higher than the camera choice. Frankel et al. Believe that a simple corner solution system is easier to verify than a complex intermediate exchange rate system. For example, in order to test whether the government keeps its promise simply pegged, market participants only need to verify whether yesterday s exchange rate is the same as today s exchange rate; in order to check whether the government has implemented a fully floating promise, it is only necessary to check whether the government s monthly foreign exchange reserve changes are the same That is, to see if the government has used foreign exchange reserves to intervene in the foreign exchange market. But such verification of the intermediate exchange rate system is very difficult.

Yi Gang and Tang Xian established the choice model of exchange rate system when the government led. The results of the model solution show that the main parameters that determine the choice of the exchange rate system are roughly consistent with the optimal currency area standard. At this time, no exchange rate system is applicable to all countries and all periods. The development of financial derivatives not only provides tools for evading exchange rate risks, but also enables large-scale speculative attacks. In the new market-led environment, the public moral hazard behavior caused by the intermediate exchange rate system's attempt to provide free exchange rate risk insurance, and the intermediate exchange rate system's choice as a camera of the executive branch rather than laws made by the legislative branch, A crisis of trust in the government's commitments has led to speculative attacks endogenously and caused public panic, which has inevitably created a currency crisis. The reaction of the exchange rate system to public confidence proves that the intermediate exchange rate system is unstable. In the context of global economic integration, the "corner exchange rate system" as a rule will be the only stable solution. This hypothesis overcomes the limitation of the traditional Mundell triangle analysis on the choice of exchange rate system, and proposes an extended triangle hypothesis. The extended triangle hypothesis shows that an intermediate exchange rate system can exist. When the requirement of efficiency leads to the complete flow of regional capital in various countries around the world, the development trend of the exchange rate system is to shift to more flexible or regional alliances. The ultimate trend will be that the corner point system has an absolute advantage. At that time, the full float will be preserved with the monetary union, and the monetary union will float completely externally. Corden analyzed the lessons of the choice of exchange rate regimes in Europe and Asia and concluded that emerging market countries should implement an intermediate exchange rate system, that is, a flexible pegged exchange rate system, which is close to managed floating.

Fisher also pointed out that every major crisis related to international capital markets since 1994 (Mexico in 1994, Thailand, Indonesia and South Korea in 1997, Russia and Brazil in 1998, Argentina and Turkey in 2000) must The degree is related to the fixed or pegged exchange rate system. At the same time, countries that do not have pegged exchange rates, South Africa, Israel in 1998, Mexico in 1998, and Turkey in 1998 avoided the crisis of the newly industrialized countries that pegged their exchange rates. Policy makers in anti-crisis countries strongly warned that countries with open capital accounts should not implement adjustable pegging exchange rates and other soft pegging exchange rate systems, implement bipolar exchange rate systems or corner exchange rate systems, that is, choose hard pegging. The exchange rate system or floating exchange rate system, the exchange rate system between the two is not sustainable. Fisher also pointed out that for emerging market countries, the pegged exchange rate system cannot last long unless it is very hard; there can be a wide range of flexible exchange rate systems; it is expected that most countries will respond to changes in exchange rates. For these emerging market countries, the implementation of adjustable pegged exchange rate systems and exchange rate systems that fluctuate within a narrow range should be excluded. But for other developing countries where capital is not yet highly mobile, that is, non-emerging market economies, all exchange rate regimes are available. As more countries implement a hard-pegged exchange rate system, including dollarization and currency unions, there will be fewer and fewer independent national currencies in the future. The exchange rates between the remaining independent currencies will be mostly floating, with only large countries, whose monetary policies and occasional intervention in the foreign exchange market will respond to nominal exchange rates and sometimes affect nominal exchange rates.

Fisher insists that in the medium term, as it has happened in recent years, the exchange rate system tends to be more pegged to the exchange rate system due to the reduction of the intermediate exchange rate system. However, in the long run, the choice of exchange rate system will depend on the operation of the euro and dollarized economy, and it will be possible to move from floating to hard pegging.