The Mirage of Exchange Rate Regimes for Emerging Market Countries

TLDR

Standard theory of exchange‑rate regime choice is critiqued for its weaknesses when applied to emerging markets. The paper argues that the debate on exchange‑rate regime choice is misguided and examines how institutional traits influence and are influenced by regime choice. The authors analyze institutional traits that predispose countries to fixed or floating regimes and assess whether regime choice can foster desirable institutional development. The study finds that exchange‑rate regime choice is a secondary factor compared to institutional quality, and that prioritizing institutional reforms over regime selection can promote macroeconomic stability and reduce crises in emerging markets.

Abstract

This paper argues that much of the debate on choosing an exchange rate regime misses the boat. It begins by discussing the standard theory of choice between exchange rate regimes, and then explores the weaknesses in this theory, especially when it is applied to emerging market economies. It then discusses a range of institutional traits that might predispose a country to favor either fixed or floating rates, and then turns to the converse question of whether the choice of exchange rate regime may favor the development of certain desirable institutional traits. The conclusion from the analysis is that the choice of exchange rate regime is likely to be of second order importance to the development of good fiscal, financial, and monetary institutions in producing macroeconomic success in emerging market countries. This suggests that less attention should be focused on the general question whether a floating or a fixed exchange rate is preferable, and more on these deeper institutional arrangements. A focus on institutional reforms rather than on the exchange rate regime may encourage emerging market countries to be healthier and less prone to the crises that we have seen in recent years.