Exchange Rate Economics: Theories and Evidence

28 Introduction
1.9 Exchange rate regimes
The standard textbook definition of an exchange rate regime usually makes the
stark distinction between fixed and floating,or flexible,exchange rates and on
that basis describes a variety of historical exchange rate regimes,namely,the
Classical Gold standard,1870–1914,in which participating countries by fixing
their currencies to one ounce of gold fixed their bilateral exchange rates; the interwar
gold exchange (fixed rate) standard; the inter-war floating rate experience; the
Bretton Woods fixed,but adjustable,exchange rate regime in which currencies
were fixed to the dollar; and the post-Bretton Woods regime in which exchange
rates have supposedly been flexible. However,between the textbook cases – what
is now referred to as the corner cases – there are various shades of grey and as we
shall see the polar case of extreme fixity needs to be more carefully defined.
Nearly all of the empirical studies referred to in this book have used the official
or ‘standard’ classification of an exchange rate regime published by the IMF in its
Annual Report on Exchange Rate Arrangement and Exchange Restrictions. Until 1997,the
IMF asked member states to make a self-declaration of their exchange rate relationship
as belonging to four categories,namely,fixed,limited flexibility,managed
floating and independently floating. 14 However,as Calvo and Reinhart (2002),
Levi-Yeyati and Sturzeneger (2002) and Reinhart and Rogoff (2002) point out,
often times when a regime was classified as either independently floating,or a
managed float,the reality was rather different in the sense that the country had a
de facto fixed peg or crawling peg. Furthermore,Reinhart and Rogoff (2002) point
out that in the post-World War II period nearly every country has relied at some
point in time on either capital controls or dual exchange rates and so the officially
reported exchange rate is likely to be ‘profoundly misleading’. For example,
they report that in 1950,45% of countries in their sample of 150 countries had
dual rates and many more countries had thriving parallel markets. Furthermore,
amongst the more important currencies,the UK had multiple exchange rates into
the 1970s,Italy in the 1980s and Belgium and Luxembourg until 1990.
Indeed,on using market-determined rates,instead of official rates,Reinhart
and Rogoff (2002) find that de facto floating was not uncommon during the Bretton
Woods period of pegged exchange rates – 45% of countries that were supposedly
on pegged regimes were in fact on some form of managed float and they go as far
as to suggest that it is difficult to detect any change in exchange rate behaviour
between the Bretton Woods and post-Bretton Woods regimes which clearly has
important implications for findings of regime volatility discussed earlier and again
in Chapters 6 and 11 later.
Since 1997,the IMF has fleshed out the rich variety of intermediate cases
between the so-called corner positions of a pure float and a rigidly fixed exchange
rate,as exists in a monetary union,and here we follow a similar taxonomy,proposed
by Frankel (2003). He distinguishes seven intermediate cases between the
two extreme corners of a pure float and participation in a monetary union,each
of which can have numerous further variants. In Table 1.5 we present a slightly
modified version of Frankel’s categorisation.