CHAPTER II DEVELOPMENTS AND ISSUES IN EXCHANGE RATE REGIMES
Author: International Monetary Fund
Language:
English
Keywords:
WEFS; exchange rate; regime; market; exchange rate volatility; peg regime; band regime; policy mix; floating regime; floating exchange rate regime; Exchange rate arrangements; Conventional peg; Crawling peg; Exchange rates; Exchange rate flexibility
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Abstract

This chapter reviews country experiences in the use of different exchange rate regimes and their trends since 1990, and discusses some of the factors underlying these trends. It analyzes the evolution of exchange rate regimes based on de facto policies, which have formed the basis of the IMF’s official exchange rate regime classifications since January 1999. This system classifies exchange rate regimes based on the degree of commitment to a given exchange rate path and not necessarily on the degree of flexibility of the exchange rate. It also adds a new dimension by placing members’ exchange rate regimes in their overall monetary policy framework (see Box 2.1). The de facto classification has been backdated to 1990, while providing more details on some regime categories (Figure 2.1).1

This chapter reviews country experiences in the use of different exchange rate regimes and their trends since 1990, and discusses some of the factors underlying these trends. It analyzes the evolution of exchange rate regimes based on de facto policies, which have formed the basis of the IMF’s official exchange rate regime classifications since January 1999. This system classifies exchange rate regimes based on the degree of commitment to a given exchange rate path and not necessarily on the degree of flexibility of the exchange rate. It also adds a new dimension by placing members’ exchange rate regimes in their overall monetary policy framework (see Box 2.1). The de facto classification has been backdated to 1990, while providing more details on some regime categories (Figure 2.1).1

Figure 2.1.
Figure 2.1.

De Facto Classification of Exchange Rate Regimes

De Facto Classification of Exchange Rate Regimes and Monetary Policy Framework

This classification system is based on members’ actual, de facto, regimes, which may differ from their officially announced arrangements. The scheme ranks exchange rate regimes on the basis of the degree of flexibility of the arrangement or formal or informal commitment to a given exchange rate path. It distinguishes between the more rigid forms of pegged regimes, such as currency board arrangements; other conventional fixed peg regimes against a single currency or a basket of currencies; exchange rate bands around a fixed peg; crawling peg arrangements; and exchange rate bands around crawling pegs, in order to help assess the implications of the choice of exchange rate regime for the degree of independence of monetary policy. This includes a category to distinguish the exchange arrangements of those countries that have no separate legal tender. The new system presents members’ exchange rate regimes against alternative monetary policy frameworks, with the intention of using both criteria as a way of providing greater transparency in the classification scheme and to illustrate that different forms of exchange rate regimes could be consistent with similar monetary frameworks. The following explains the categories.

Exchange Rate Regimes

Exchange Arrangements With No Separate Legal Tender

The currency of another country circulates as the sole legal tender (formal dollarization), or the member belongs to a monetary or currency union in which the same legal tender is shared by the members of the union. Adopting such regimes is a form of surrendering the monetary authorities’ independent control over domestic monetary policy.

Currency Board Arrangements

A monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure the fulfillment of its legal obligation. This implies that domestic currency be issued only against foreign exchange and that it remain fully backed by foreign assets, eliminating traditional central bank functions, such as monetary control and lender-of-last-resort, and leaving little scope for discretionary monetary policy; some flexibility may still be afforded, depending on how strict the rules of the boards are.

Other Conventional Fixed Peg Arrangements

The country (formally or de facto) pegs its currency at a fixed rate to another currency or a basket of currencies, where the basket is formed from the currencies of major trading or financial partners and weights reflect the geographical distribution of trade, services, or capital flows. The currency composites can also be standardized, such as those of the SDR. There is no commitment to keep the parity irrevocably. The exchange rate may fluctuate within a narrow margin of less than ±1 percent around a central rate or the maximum and minimum value of the exchange rate may remain within a narrow margin of 2 percent for at least three months. The monetary authority stands ready to keep the fixed parity through direct intervention (i.e., via sale/purchase of foreign exchange in the market) or indirect intervention (e.g., via aggressive use of interest rate policy, imposition of foreign exchange regulations or exercise of moral suasion that constrains foreign exchange activity, or through intervention by other public institutions). Flexibility of monetary policy, though limited, is greater than in hard pegs, because traditional central banking functions are still possible, and the monetary authority can adjust the level of the exchange rate, although relatively infrequently.

Pegged Exchange Rates Within Horizontal Bands

The value of the currency is maintained within certain margins of fluctuation of at least ±1 percent around a formal or a de facto fixed central rate. It also includes the arrangements of the countries in the exchange rate mechanism (ERM) of the European Monetary System (EMS) that was replaced with ERM-II on January 1, 1999. There is a limited degree of monetary policy discretion, with the degree of discretion depending on the band width.

Crawling Pegs

The currency is adjusted periodically in small amounts at a fixed rate or in response to changes in selective quantitative indicators, such as past inflation differentials vis-à-vis major trading partners, differentials between the target inflation and expected inflation in major trading partners, and so forth. The rate of crawl can be set to generate inflation-adjusted changes in the currency (backward looking), or set at a preannounced fixed rate and/or below the projected inflation differentials (forward looking). Maintaining a credible crawling peg imposes constraints on monetary policy in a similar manner as a fixed peg system.

Exchange Rates Within Crawling Bands

The currency is maintained within certain fluctuation margins of at least ±1 percent around a central rate, which is adjusted periodically at a fixed rate or in response to changes in selective quantitative indicators. The degree of flexibility of the exchange rate is a function of the width of the band, with bands chosen to be either symmetric around a crawling central parity or to widen gradually with an asymmetric choice of the crawl of upper and lower bands (in the latter case, there may not be a preannounced central rate). The commitment to maintain the exchange rate within the band continues to impose constraints on monetary policy, with the degree of policy independence being a function of the band width.

Managed Floating With No Predetermined Path for the Exchange Rate

The monetary authority influences exchange rate movements through active intervention to counter the long-term trend of the exchange rate without specifying a predetermined exchange rate path or without having a specific exchange rate target. Indicators for managing the rate are broadly judgmental, e.g., balance of payments position, international reserves, parallel market developments, and adjustments may not be automatic. Intervention may be direct or indirect. A distinction is made between “tightly managed floating”—where intervention takes the form of very tight monitoring that generally results in a stable exchange rate without having a clear exchange rate path, with the aim of permitting authorities an extra degree of flexibility in deciding the tactics to achieve a desired path—and “other managed floating,” where the exchange rate is influenced in a more ad hoc fashion.

Independently Floating

The exchange rate is market determined, with any foreign exchange intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it. In these regimes, monetary policy is, in principle, independent of exchange rate policy.

Monetary Policy Framework

The exchange rate regime is presented against alternative monetary policy frameworks in order to present the role of the exchange rate in broad economic policy and help identify potential sources of inconsistency in the monetary-exchange rate policy mix.

Exchange Rate Anchor

The monetary authority stands ready to buy/sell foreign exchange at given quoted rates to maintain the exchange rate at its pre-announced level or range; the exchange rate serves as the nominal anchor or intermediate target of monetary policy. This type of regime covers exchange rate regimes with no separate legal tender; CBAs; fixed pegs with and without bands; and crawling pegs with and without bands, where the rate of crawl is set in a forward-looking manner.

Monetary Aggregate Anchor

The monetary authority uses its instruments to achieve a target growth rate for a monetary aggregate, such as reserve money, M1, and M2, and the targeted aggregate becomes the nominal anchor or intermediate target of monetary policy.

Inflation Targeting Framework

This involves the public announcement of medium-term numerical targets for inflation with an institutional commitment by the monetary authority to achieve these targets. Additional key features include increased communication with the public and the markets about the plans and objectives of monetary policymakers and increased accountability of the central bank for obtaining its inflation objectives. Monetary policy decisions are guided by the deviation of forecasts of future inflation from the announced inflation target, with the inflation forecast acting (implicitly or explicitly) as the intermediate target of monetary policy.

Fund-Supported or Other Monetary Program

This involves implementation of monetary and exchange rate policies within the confines of a framework that establishes floors for international reserves and ceilings for net domestic assets of the central bank. Because the ceiling on net domestic assets limits increases in reserve money through central bank operations, indicative targets for reserve money may be appended to this system.

Other

The country has no explicitly stated nominal anchor but rather monitors various indicators in conducting monetary policy, or there is no relevant information available for the country.

The remainder of this chapter discusses whether exchange rate regimes based on members’ de facto policies have shifted away from intermediate regimes toward hard peg or floating regimes since 1990 and, if so, in which direction. It also examines whether certain types of exchange rate regimes have been subject to more frequent exits and severe market pressures. It then discusses factors underlying the evolution of exchange rate regimes, including exchange regulations, the monetary policy framework, and integration with international capital markets. The chapter also reviews the experience with the new classification scheme and issues related to its implementation.

Evolution of Exchange Rate Regimes Since 1990

There has been a marked shift away from pegged exchange rate regimes toward floating regimes since 1990, as assessed by the official notification of country authorities to the IMF. Based on the IMF’s de jure classification of exchange rate regimes, the share of member countries with pegged exchange rate regimes—including regimes with limited flexibility within a band and the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS)—declined to 44 percent in 1998 from about 65 percent in 1990 (Figure 2.2 and Table 2.1). This apparent trend toward greater exchange rate flexibility has been questioned because some countries have targeted or tightly managed their exchange rates in reality, while declaring officially that they were implementing floating regimes. Such deviations between de jure and de facto policies reflected, among other things, the political implications of exchange rate depreciations and concerns about the impact of depreciations on financial and nonfinancial institutions and inflation.2

Figure 2.2
Figure 2.2

Evolution of Exchange Rate Regimes in IMF Member Countries

(In percent of IMF membership)

Sources: IMF, International Financial Statistics; andBubulaand Ötker-Robe (2002a).1Includes arrangements with no separate legal tender, currency boards, conventional fixed pegs, and horizontal bands.21998 figures refer to September 1998, which is the last date the de jure classification system was updated.3Includes arrangements with no separate legal tender, currency boards, conventional fixed pegs, and horizontal bands, crawling pegs and crawling bands.
Table 2.1.

Evolution of Exchange Rate Regimes

(In percent of IMF membership)

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Sources: IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues; and Bubula and Ötker-Robe (2002a).

The de jure classification has not been updated since September 1998.

Includes arrangements with no separate legal tender, currency boards, conventional fixed pegs and horizontal bands, and regimes with limited flexibility within a band and the EMS’s ERM.

Comprises arrangements with another currency as legal tender (i.e. dollarization), currency unions, and currency boards.

Comprises conventional fixed pegs vis-à-vis a single currency or a basket, horizontal bands, and crawling pegs and bands.

Includes tightly managed floating regimes.

Defined as including tightly managed floating regimes and soft peg regimes.

Indeed, the move toward more flexible exchange rate regimes has been less pronounced when members’ de facto policies were taken into account. Countries with floating regimes, while almost doubling their share in 1998 compared to 1990, made up only slightly more than one-third of the IMF membership in 1998, based on the de facto classification, instead of the more than one-half as suggested by the de jure classification (Table 2.2 and Appendix Table 2.A1). The difference between the two classifications in the share of floating regimes partly reflects the fact that the countries informally pegging their currencies and those managing their exchange rates along a predetermined target path (for example, crawling peg or crawling band regimes) are classified as pegged regimes in the de facto classification and not as floating regimes. As a result, more than one half of IMF members were still pursuing various forms of pegged regimes at end-2001. While pegged regimes have remained dominant, there has been a discernible shift within these regimes over the past decade, away from softer pegs toward harder pegs. The share of the latter rose to more than 46 percent of all pegged regimes in 2001 from less than 20 percent in 1990, offsetting the drop in the share of soft pegs (Figure 2.3).

Table 2.2.

Frequency of Regime Shifts Under Alternative Exchange Rate Regimes, 1990–2001

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Source: Bubula and Ötker-Robe (2002a).

Indicates the total number of exits from each regime during the period January 1990–December 2001.

Defined as the total number of exits from a given regime as a ratio of the total number of observations during which the regime was in effect over the sample.

Figure 2.3
Figure 2.3

Evolution of Pegged Exchange Rate Regimes in IMF Member Countries

Sources: Bubula and Ötker-Robe (2002a)

The de facto exchange rate classification indicates a trend away from intermediate regimes toward the two ends of the spectrum of exchange rate regimes (Figure 2.4 and Appendix Table 2.A2). This trend may provide some support for the “bipolar” or “shrinking middle” view of exchange rate regimes, which suggests that intermediate regimes, including soft pegs and tightly managed floats, would eventually vanish. With such regimes at center stage in major currency crises over the past decade, there has been growing support for the view that floating or truly fixed exchange rate regimes are the only ones compatible with increased capital mobility.3

Figure 2.4
Figure 2.4

Polarization of Exchange Rate Regimes Across Country Groups1

(In percent of membership in each group)

Source: IMF staff estimates.1 Hard pegs = formal dollarization + currency unions + currency boards. Intermediate = conventional fixed pegs + horizontal bands + crawling pegs + crawling bands + tightly managed floats. Floating = independenty floats + other managed floats with no predetermined path for the exchange rate.2The definitions of the developed and developing countries coincide with that of the International Financial Statistics. The list of emerging market countries is based on a number of existing definitions that combine the countries included in the Emerging Markets Bond Index Plus (EMBI+) and Morgan Stanley Capital International (MSCI) index, with a few exceptions: Greece is included in the developed countries group and Singapore and Hong Kong are included in the emerging countries group. This gives a list of 32 countries: Argentina, Brazil, Bulgaria, Chile, China, Colombia, Czech Republic, Egypt, Ecuador, Hong Kong SAR, Hungary, India, Indonesia, Israel, Jordan, Republic of Korea, Malaysia, Mexico, Morocco, Nigeria, Pakistan, Panama, Peru, Philippines, Poland, Russia, Singapore, South Africa, Sri Lanka, Thailand, Turkey, and Republica Bolivariana de Venezuela.

This view, however, has been challenged on several grounds, including by the lack of strong empirical evidence that intermediate regimes are vanishing (Masson, 2001) and by the observation that corner solutions are not immune to crises (Williamson, 2000). The collapse of Argentina’s currency board agreement in January 2002 suggests that even hard pegs cannot prevent a crisis in the absence of necessary domestic and external conditions, in particular appropriate macro-economic and financial policies.

There have also been notable shifts within the intermediate regimes. Countries have tended to move to more flexible exchange rates within the intermediate regimes; for instance, the share of countries with crawling bands increased while that of those maintaining conventional fixed pegs and crawling pegs declined significantly (Figure 2.5 and Appendix Table 2.A3). In addition, there seems to have been a growing tendency to choose single currency pegs, as opposed to pegs to a basket of currencies, in both fixed and crawling peg regimes. Crawling pegs also became more forward looking, as countries assigned greater weight to disinflation objectives and moved away from real exchange rate targeting rules designed to safeguard export competitiveness.4

Figure 2.5
Figure 2.5

Evolution of Intermediate Regimes of IMF Members

Sources: Bubula and Ötker-Robe (2002a)

The shift away from intermediate regimes has been more pronounced among developed and emerging market countries and less pronounced for other IMF members (see Figure 2.4 and also Fischer, 2001). In the developed countries, the launching of the EMU in January 1999 accounted for most of the significant movement from intermediate regimes to hard pegs, although part of the decline reflected the fact that a number of European countries floated during the ERM turmoil of 1992–93 (for example, Norway, Sweden, and the United Kingdom). In the emerging market countries, there has been a marked shift toward floating regimes. More flexible regimes were adopted in many countries that faced a sudden reversal of large capital inflows in the 1990s (for example, Brazil, Colombia, the Czech Republic, Indonesia, Korea, Mexico, the Philippines, Russia, Thailand, and Turkey). A few countries experiencing large capital inflows gradually moved to more flexible exchange rate regimes to enhance monetary policy autonomy in keeping inflation low (for example, Chile and Poland). Several emerging market countries adopted more rigid exchange rate regimes (for example, Argentina, Bulgaria, and Ecuador), with the hope of enhancing policy credibility and stabilizing their economies. For most developing countries with limited access to international capital markets and for transition economies as a whole, intermediate regimes have remained dominant.

The degree of polarization of exchange rate regimes has varied across regions (Figures 2.6 and 2.7). The intermediate regimes contracted most notably in Europe (mainly in the late 1990s as part of a long-planned effort toward political and economic integration), with the shift evenly distributed between floating and hard peg regimes. In Africa, a number of countries gradually adopted more flexible exchange rate policies. Intermediate regimes remained common in Asia and Latin America, although their share declined significantly in the late 1990s as a result of the financial crises in these regions. In the small island economies in the Caribbean and Pacific, and in the Middle Eastern countries, no significant change in the composition of regimes has been observed.

Figure 2.6
Figure 2.6

Polarization of Exchange Rate Regimes Across Regions1

(In percent of membership in each group)

Source: IMF staff estimates.1 Hard pegs = formal dollarization + currency unions + currency boards. Intermediate = conventional fixed pegs + horizontal bands + crawling pegs + crawling bands + tightly managed floats. Floating = independently floats + other managed floats with no predetermined path for the exchange rate.
Figure 2.7
Figure 2.7

Exchange Rate Regimes by Country

Sources: IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues; and Bubula and Ötker-Robe (2002a).1In January 2002, Argentina’s currency board arrangement was replaced with a dual exchange rate system, which was subsequently abandoned in February 2002 for a floating exchange rate regime. Similarly, Republica Bolivariana de Venezuela’s crawling band regime was replaced with a floating exchange rate regime in January 2002.

The exchange rate regime shifts during 1990–2001 do not indicate a particular exit pattern. Most intermediate regimes exited to a floating regime, rather than to hard pegs, although certain intermediate regimes were replaced by other intermediate regimes before eventually shifting to a float (Figure 2.8). Slightly more than half of the shifts across all types of regimes involved exits to more flexible regimes and the remaining to less flexible regimes (Figure 2.9 and Table 2.2).5 Also, a larger proportion of the exits toward greater flexibility involved a move to floating regimes, while most of the regime shifts toward less flexibility was to soft peg regimes, as opposed to hard peg regimes (Appendix Table 2.A4).6 With only about one-third of the exits to more flexible regimes and about one-fourth of the regime shifts during 1990–2001 associated with severe foreign exchange market pressure episodes,7 most exits appear to represent orderly regime shifts.

Figure 2.8
Figure 2.8

Exits from Intermediate Regimes to Other Regimes, 1990–2001

(In percent of all exits within each country group)

Source: Bubula and Ötker-Robe (2002a).
Figure 2.9
Figure 2.9

Number and Nature of Exchange Rate Regime Exits

(Number of exits)

Sources: Bubula and Ötker-Robe (2002a, 2002b).1Severe pressure episodes were identified as periods when a market pressure index computed as a weighted average of monthly exchange rate depreciations and interest rate increases exceeded its sample mean by at least three standard deviations. The weights were computed so as to make the sample standard deviations of each series equal. Sample means and standard deviations for hyperinflation episodes were computed separately as in Kaminsky and Reinhart (1999). For countries where interest rate data were not available for sufficiently long periods, the episodes were identified as periods when the monthly exchange rate depreciation was at least 5 percent and deviated from the previous month’s depreciation by at least 3 percentage points, and when the monthly depreciation exceeded its mean by at least two standard deviations (both mean and standard deviations are country specific).

The exit episodes suggest that certain exchange rate regimes have been more exit prone and somewhat more subject to severe market pressure relative to other regimes. The frequency of exits from intermediate regimes during 1990–2001 was generally higher relative to exits from hard pegs (Table 2.2). Moreover, the frequency of episodes related to severe market stress is also higher for intermediate regimes (Table 2.3). The hard peg regimes were least subject to exits,8 and the frequency of severe market pressure under these regimes was much less than that of intermediate and floating regimes.

Table 2.3.

Distribution of Episodes of Severe Exchange Market Pressure Across Exchange Rate Regimes, 1990–20011

(In percent, unless otherwise noted)

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Source: Bubula and Ötker-Robe (2002b).

Severe pressure episodes were identified as periods when a market pressure index computed as a weighted average of monthly exchange rate depreciations and interest rate increases exceeded its sample mean by at least three standard deviations. The weights were computed so as to make the sample standard deviations of each series equal. Sample means and standard deviations for hyperinflation episodes were computed separately as in Kaminsky and Reinhart (1999).

The frequency of pressure under each regime is computed as the number of severe pressure episodes under each regime as a ratio of the total number of observations in which that regime was in effect over the sample.

Within the intermediate regimes, certain regimes appeared to face more frequent market pressure than others. For example, horizontal bands and conventional fixed pegs to a single currency or to a basket of currencies came under more frequent market pressure than other intermediate regimes, such as the crawling bands and tightly managed floats9 (Figure 2.10). The exit rate, however, was not always higher for the regimes subject to more frequent market pressures than those experiencing less frequent market pressures.10 Statistical evidence indicated that overall crawling pegs were the most exit prone, followed by horizontal bands, tightly managed floats, and crawling bands.11

Figure 2.10
Figure 2.10

Frequency of Market Pressure and Exits Across Intermediate Regimes, 1990–2001

(In percent)

Sources: Tables 2.2 and 2.3.

Some aspects of the prevailing exchange rate regimes certainly contributed to the most well known crises in the past decade. Eight out of nine countries reviewed in this paper that experienced crises during this time period maintained an intermediate regime, and one had a hard peg—a currency board (Table 2.4). Under such regimes, the relatively stable exchange rate and high domestic interest rates compared with international interest rates attracted capital flows—especially short term—and thus increased vulnerability to a sudden reversal of such inflows. Exchange rate stability also encouraged excessive and unhedged borrowing by the public and private sectors, increasing susceptibility to large depreciations that contributed to financial stress directly or indirectly through the banking system. The limited flexibility of the exchange rate also contributed to a worsening of external balances.

Table 2.4.

Sources of Vulnerabilities in Selected Crisis and Noncrisis Countries That Experienced Market Pressures

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Sources: Information provided by country authorities: and various IMF country reports.

The prevailing exchange rate regimes were not the only source of market stress, however. The country experiences suggest that the inconsistency between economic and financial policies and the prevailing exchange rate regime were key factors in most crisis cases examined. Weaknesses in the condition and supervision of the banking system and in fiscal policies, and lack of progress in crucial structural reforms were important sources of vulnerabilities under-mining exchange rate regimes.12 Such weaknesses and vulnerabilities were not prevalent in the noncrisis countries that experienced temporary exchange market pressures, although they pursued similar exchange rate regimes.

Factors Underlying the Evolution of Exchange Rate Regimes

The evolution of exchange rate regimes since 1990 appears to have been influenced by changes in certain exchange regulations and in the monetary policy framework, and by the degree of integration with international capital markets.

Exchange Regulations

Countries that adopted more flexible exchange rate regimes in general tended to eliminate dual or multiple exchange rates. The share of countries maintaining dual or multiple exchange rate systems more than halved between 1990 and 2001, while the share of those with floating regimes more than doubled (Figure 2.11).13 At the end of 2001, 15 of the 18 countries with dual or multiple exchange rates maintained either pegged or managed exchange rate regimes.14 The elimination of dual or multiple exchange rate regimes has often been associated with the adoption of floating exchange rates.15 In a few cases, however, the introduction of dual or multiple exchange rates was accompanied by the adoption of a more flexible exchange rate regime.16 One possible explanation for this trend is that moving to a more flexible regime may reflect increased exchange market pressure that prompts the authorities to allow only specified transactions at a more flexible exchange rate. The reason for such a move is to achieve a gradual depreciation and avoid a potential overshooting that might occur under a full float.17

Figure 2.11
Figure 2.11

Evolution of Exchange Rate Structure and Regimes of IMF Member Countries

(In percent of IMF membership)

Sources: IMF, Annual Report on Exchange Arrangements and Exchange Restrictions; and Bubula and Ötker-Robe (2002a).1Includes countries with independently floating and managed floating regimes with no predetermined path for the exchange rate.2Includes countries that maintain dual and multiple exchange rates for different types of transactions.

Many countries continued to support their exchange rates through administrative measures to augment the supply of foreign exchange. As of end-2001, about 53 percent of the countries with export repatriation requirements and about 67 percent of the countries with export surrender requirements maintained pegged exchange rate regimes (Table 2.5). In particular, about 60 percent of the countries that maintain conventional fixed pegs supported their regimes by repatriation or surrender requirements for export proceeds. Some countries that eliminated surrender requirements in 1997–2001 moved to more flexible regimes within a period of about a year (for example, Kazakhstan, Liberia, the Slovak Republic, and Slovenia).

Table 2.5.

Exchange Rate Regimes and Various Aspects of Exchange Systems at End-2001

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Sources: Bubula and Ötker-Robe (2002a); and IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues.

Includes the shares of countries with no separate legal tender, currency board, conventional fixed peg, crawling peg, and horizontal and crawling band regimes.

Monetary Policy Framework

The move toward greater exchange rate flexibility has also reflected changes in the role of exchange rate policy within the overall monetary policy framework. Many countries have adopted hard or conventional pegged regimes to help reduce inflationary expectations and increase economic policy credibility in the early phases of stabilization programs. The eventual emergence of tensions between the objectives of lowering inflation and improving external competitiveness has been a significant factor in moving to more flexible exchange rate regimes willingly or not; some countries moved to more flexible forms of pegged regimes while others chose floating regimes. A number of countries have adopted crawling band arrangements to address the tensions between inflation and external objectives, as-well as to discourage speculative capital flows. Such regimes were quite common until the late 1990s because, to some extent, they retained an anchor role for the exchange rate through a predetermined depreciation path, while providing the flexibility to prevent serious exchange rate misalignments and to deal with capital flows. More recently, however, the use of such regimes has declined because a number of these regimes came under speculative attacks that ended in the floating of the exchange rate (for example, Colombia, Ecuador, Indonesia, Mexico, and Sri Lanka). A few countries, such as Chile and Poland, exited to greater exchange rate flexibility in a relatively tranquil period.

There has been a corresponding decline in the use of the exchange rate as a nominal anchor of monetary policy in favor of explicit inflation targeting. In particular, a growing number of emerging market economies have abandoned their pegged exchange rate regimes and moved toward flexible regimes and inflation targeting (Figure 2.12). Of the 18 countries that had inflation targeting as the main monetary framework at end-2001, 15 had independently floating regimes (Appendix Table 2.A5). Several countries adopted inflation targeting following the floating of their currencies during a currency crisis (for example, Brazil, the Czech Republic, Korea, Mexico, and Thailand), reflecting a less favorable experience with the use of the exchange rate as a nominal anchor, the instability of money demand in such an environment, and the desire to enhance the credibility and transparency of monetary policy. Several countries floated their currencies and adopted inflation targeting as the main anchor of monetary policy (for example, Iceland and Poland). Others adopted monetary targets when preconditions for an effective implementation of inflation targeting were not in place (for instance, Turkey after floating the exchange rate in 2001). A few others continued to have multiple anchors, although their use has declined since 1997.18

Figure 2.12
Figure 2.12

Monetary Policy Framework of IMF Member Countries1

(In percent of IMF membership)

Source: IMF, International Financial Statistics, various issues.1 Only one monetary policy anchor is assigned to each country, even when there are more anchors than one, in order to avoid double counting. For example, if a country has exchange rate targets within a pegged exchange rate regime and maintains monetary or inflation targeting, it is assigned an exchange rate anchor. An IMF-supported or other monetary program is assigned to a country only when there is no other explicitly stated nominal anchor. The “other” category is used when the country has employed a variety of indicators to conduct monetary policy or when no relevant information is available.

Integration with International Capital Markets

Greater integration with international capital markets has influenced the choice of exchange rate regimes in many countries. It has been argued that the observed trend away from intermediate regimes toward the two polar regimes reflects the view that intermediate regimes are not viable for any lengthy period, particularly for countries highly integrated with international capital markets.19 The viability of soft peg regimes has been questioned because many countries failed to maintain a pegged exchange rate while directing monetary policy to achieve domestic goals in an environment with increased capital mobility. Statistical evidence suggests that the greater integration with international capital markets, measured by changes in gross cross-border private capital inflows and outflows, has been accompanied by a decline in the share of intermediate regimes in both developed and emerging market countries (Figure 2.13).20

Figure 2.13
Figure 2.13

Exchange Rate Regimes and Measurement of Capital Mobility1

Sources: IMF, International Financial Statistics;Bubula and Ötker-Robe (2002a), and IMF staff estimates.1 Capital mobility is measured by the average of the ratio of the sum of private gross capital inflows and outflows (e.g., foreign direct investment, portfolio, and other investments) as a percentage of nominal GDP in each country in the group. When data for a particular category in a given year (and country) are not available, the measure excludes that observation in the simple average.

Countries adopted different exchange rate regimes in response to growing capital flows in the past decade. Some countries were forced to move to greater exchange rate flexibility following a series of speculative attacks, particularly when inconsistencies in the financial and monetary-exchange rate policy mix resulted in substantial inflows of capital and their subsequent reversal in several countries: Mexico (1994), Russia (1998), Indonesia and Thailand (1997), Brazil, Colombia, and Ecuador (all in 1999), and Argentina (end-2001). Others deliberately moved to greater flexibility, either by increasing the flexibility of their pegged regimes or by floating, to minimize the potential sources of vulnerabilities from implicit exchange rate guarantees or to enhance monetary policy autonomy in achieving domestic objectives. Several countries moved toward more rigid exchange rate regimes to enhance policy credibility,21 while in some countries this option was foreclosed by a severe deterioration in economic conditions and/or the absence of institutional requirements (for example, Indonesia and Russia). A few countries imposed capital and exchange controls to support the introduction of pegged regimes while directing their monetary policies to domestic objectives (for example, Malaysia in 1998 and Venezuela in 1994, see Ariyoshi and others, 2000).

Issues in the Classification of Exchange Rate Regimes

The IMF’s adoption of the de facto classification of exchange rate regimes represents an effort to achieve greater policy transparency and to strengthen the surveillance of the international monetary system. The de facto classification system requires IMF staff to make a judgment on the actual exchange rate arrangements and the monetary policy anchors adopted by countries. This judgment is based on information obtained in Article IV consultation discussions, provision of technical assistance to member countries, regular contacts with area department staff, and an examination of the nominal and real exchange rate movements.

The de facto system has helped to clarify the nature and role of members’ exchange rate regimes and has facilitated discussions with country authorities about their implementation of exchange rate policy. In the cases where regimes announced by country authorities deviate significantly from the staff’s de facto classifications, efforts have been made to obtain clarification—mainly through Article IV consultation discussions.22 For countries where dual or multiple exchange rates remain in place, available data on all the relevant exchange rates have been examined to assess the degree of true exchange rate flexibility. These efforts have helped to enhance the effectiveness of surveillance of members’ exchange rate arrangements and to identify potential inconsistencies in the mix of monetary and exchange rate policies.

Some difficulties have been experienced in the implementation of the de facto classification system. Assessing exchange rate policies is complicated where countries use direct or indirect intervention to informally target the exchange rate, while officially declaring a floating exchange rate regime. The approach taken by the staff in these countries has been to supplement data on nominal or real exchange rates and international reserves with other evidence that indicates the authorities may be pursuing an informal exchange rate target, for example, through the use of interest rate defense or other intervention measures. Such information has also been used to distinguish between managed and independently floating regimes, as well as between tightly managed and other managed floating regimes.

There is room to strengthen further the de facto classification system and its role in the surveillance of members’ policies. To this end, the timely availability of information and its transparent presentation by member countries and the staff is particularly crucial. In addition, the de facto classification process could be complemented by further statistical analysis of changes in the exchange rate in cases where the existing classification is questionable.23

Appendix 2.1

Table 2.A1.

Exchange Rate Regimes and Anchors of Monetary Policy

(As of December 31, 2001)

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Sources: Various IMF staff reports, Recent Economic Developments, International Financial Statisitics.

A country with a * indicates that the country has more than one nominal anchor that may guide monetary policy. It should be noted, however, that it would not be possible for practical purposes to infer from this table which nominal anchor plays the principal role in conducting monetary policy.

A country with a indicates that the country has an IMF-supported or other monetary program.

These countries have a currency board arrangement.

The country has no explicitly stated nominal anchor, but rather monitors various indicators in conducting monetary policy.

Until they were withdrawn in February 2002, national currencies retained their status as legal tender within their home territories.

For El Salvador, the printing of new colones, the domestic currency, is prohibited. The existing stock of colones will continue to circulate along with the U.S. dollar as legal tender until all colon notes physically wear out.

Member maintained exchange regimes involving more than one market. The regime shown is that maintained in the major market.

The indicated country has a de facto regime, which differs from its de jure regime.

Comoros has the same arrangement with the French Treasury as do the CFA Franc Zone countries.

Exchange rates are determined on the basis of a fixed relationship to the SDR, within margins of up to ±7.25%. However, because of the maintenance of a relatively stable relationship with the U.S. dollar, these margins are not always observed.

The band width for these countries is: Cyprus (±2.25%), Denmark (±2.25%), Egypt (±3%), Hungary (±15%), and Tonga (±5%).

The band for these countries is: Belarus (±5%), Honduras (±7%), Israel (±22%), Romania (unannounced), Uruguay (±3%), and Rep. Bolivariana de Venezuela (±7.5%).

There is no relevant information available for the country.

Table 2.A2.

Evolution of Exchange Rate Regimes by Country Group

(In percent of members in each category)

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Source: Bubula and Ötker-Robe (2002a).

Comprises arrangements with another currency as legal tender (i.e., dollarization), currency unions, and currency boards.

Comprises soft pegs plus tightly managed floating regimes.

Comprises conventional fixed pegs vis-à-vis a single currency or a basket, horizontal bands, and crawling pegs and crawling bands.

Comprises independently floating regimes and managed floating with no predetermined exchange rate path, excluding tightly managed floats.

Includes 32 countries and territories: Argentina, Brazil, Bulgaria, Chile, China, Colombia, Czech Republic, Ecuador, Egypt, Hong Kong SAR, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Nigeria, Pakistan, Panama, Peru, Philippines, Poland, Russia, Singapore, South Africa, Sri Lanka, Thailand, Turkey, and Republica Bolivariana de Venezuela.

Table 2.A3.

Evolution of Intermediate Exchange Rate Regimes

(In percent of all intermediate regimes, at year-end)

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Source: Bubula and Ötker-Robe (2002a).
Table 2.A4.

Number of Regime Shifts to Various Exchange Rate Regimes, 1990–2001

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Source: Bubula and Ötker-Robe (2002a).

Indicates exits from tightly and other managed-floating and independently floating regimes to a less flexible regime (indicated in the first column).

Indicates exits from soft peg regimes (including conventional fixed pegs, crawling pegs, and horizontal and crawling bands) to a less flexible regime (indicated in the first column).

Table 2.A5.

Exchange Rate Regimes and Monetary Policy Framework

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Sources: IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues; and Bubula and Ötker-Robe (2002a).
Table 2.A6.

Countries with Dual or Multiple Exchange Rate Systems and Exchange Rate Regimes

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Sources: Bubula and Ötker-Robe (2002a); and IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues.

In August 1990, a unified floating rate regime was introduced.