chapter  5
20 Pages

Exchange rate regimes and capital mobility: How much of the Swoboda thesis survives?

ByBARRY EICHENGREEN

How will the constellation of regimes look in twenty years’ time if present trends continue? This question may be answered by using a simple Markov chain model, as in Masson (2001) and Eichengreen and Razo-Garcia (2006), to estimate the probability of regime transitions. This assumes that the past is a guide to the future and that the probability of being in a regime in the next period depends only on the current regime.9 For the sample as a whole (Bubula and Otker-Robe classification), the most persistent state is a hard peg, followed by the intermediate and, last, floating regimes (Table 5.3). There is no absorbing state and hence no tendency for countries to converge to a single regime or subset of regimes. The last line of the table shows the distribution of regimes if current trends continue for another twenty years. This suggests that in two decades 30 percent of countries will have pegs, 30 percent will have floats, and 40 percent will have intermediate arrangements. Compared to the current constellation, the share of intermediate regimes will have declined further, but only modestly. The picture looks different when calculations are done separately for advanced countries, emerging markets, and developing economies. Among the advanced countries, intermediate arrangements are the least persistent while hard pegs are an absorbing state. This, of course, is just another way of saying that no country that joined EMU since 1999 has left.10 By 2025, the share of floaters is forecast to decline from 40 percent to 30 percent of the advanced country subsample, one imagines through the adoption of the euro by additional countries.11 Among emerging markets and developing countries, in contrast, hard pegs are the most persistent regime, followed by intermediate arrangements and then floats; note that this is a different pattern than for the advanced countries.12 Here there is no strong support for the bipolar view. The Markov chain analysis suggests that the share of emerging markets and developing countries with floating rates will actually be lower in 2025 than today, reversing the trend in recent decades. This reflects the fact that intermediate arrangements are more persistent than flexible regimes in this subsample. They may be adopted infrequently, but once adopted they persist. Thus, this analysis does not suggest that intermediate regimes will disappear any time soon outside the OECD. At the same time, the contrast between the advanced, emerging and developing countries suggests that there is a tendency to move away from intermediate regimes in the course of economic and financial (and political?) development. To the extent that this is true, one can imagine that the phenomenon of the hollow middle will eventually spread from the now advanced countries to the rest of the world. One interpretation is that economic development, in practice, is associated with financial liberalization and the removal of capital controls, which heighten the fragility of intermediate regimes and prompt movement to the poles. This suggests that if developing countries follow their advanced country counterparts in pursuing financial and capital account liberalization, they will also follow them in abandoning intermediate regimes. Compared to other developing countries, emerging markets both have more open capital accounts and a greater tendency to abandon intermediate regimes (relative openness to foreign investment being how the emerging markets category is defined), consistent with this view.