Fear of Floating

TLDR

Many countries have suffered severe financial crises, especially emerging markets, and some attribute these meltdowns to fixed exchange rates, prompting a recommendation that currencies should be allowed to float. The study examines whether official exchange‑rate labels reflect actual practice across 154 arrangements and introduces a framework to explain the phenomenon of fear of floating. The authors analyze macro variables—exchange rates, reserves, monetary aggregates, interest rates, and commodity prices—across 154 regimes and develop an analytical framework to elucidate fear of floating. The findings show that most countries claiming a floating regime actually behave like noncredible pegs, revealing a pervasive fear of floating even among developed nations.

Abstract

In recent years, many countries have suffered severe financial crises, producing a staggering toll on their economies, particularly in emerging markets. One view blames fixed exchange rates-- soft pegs'--for these meltdowns. Adherents to that view advise countries to allow their currency to float. We analyze the behavior of exchange rates, reserves, the monetary aggregates, interest rates, and commodity prices across 154 exchange rate arrangements to assess whether official labels' provide an adequate representation of actual country practice. We find that, countries that say they allow their exchange rate to float mostly do not--there seems to be an epidemic case of fear of floating.' Since countries that are classified as having a free or a managed float mostly resemble noncredible pegs--the so-called demise of fixed exchange rates' is a myth--the fear of floating is pervasive, even among some of the developed countries. We present an analytical framework that helps to understand why there is fear of floating.