The mirage of floating exchange rates

CM Reinhart - American Economic Review, 2000 - pubs.aeaweb.org
American Economic Review, 2000pubs.aeaweb.org
During the past few years, many countries have suffered severe currency and banking
crises, producing a staggering toll on their economies, particularly in emerging-market
countries. In many cases, the cost of restructuring the banking sector has been in excess of
20 percent of GDP, and output declines in the wake of crisis have been as large as 14
percent. An increasingly popular view blames fixed exchange rates, specifically “soft pegs,”
for these financial meltdowns. Not surprisingly, adherents to that view advise emerging …
During the past few years, many countries have suffered severe currency and banking crises, producing a staggering toll on their economies, particularly in emerging-market countries. In many cases, the cost of restructuring the banking sector has been in excess of 20 percent of GDP, and output declines in the wake of crisis have been as large as 14 percent. An increasingly popular view blames fixed exchange rates, specifically “soft pegs,” for these financial meltdowns. Not surprisingly, adherents to that view advise emerging markets to join the ranks of the United States and other industrial countries that have chosen to allow their currency to float freely (see eg Morris Goldstein, 1999).
At first glance, the world (with the notable exception of Europe) does seem to be marching steadily toward floating exchange-rate arrangements. According to the International Monetary Fund (IMF), 97 percent of its member countries in 1970 were classified as having a pegged exchange rate; by 1980, that share had declined to 39 percent, and in 1999, it was down to only 11 percent. 1 Yet, this much-used IMF classification takes at face value that countries actually do what they say they do. Even a cursory perusal of the Asian crisis countries’ exchange rates prior to the 1997 crisis would suggest that their exchange rates looked very much like pegs to the US dollar for extended periods of time. Only Thailand, however, was explicitly classified as a peg; the Philippines was listed as having a freely floating exchange rate, while the others were lumped under the catch-all label of managed floating.
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