Exchange Rate Regimes: Fix or Float?
| Author | Mark Stone, Harald Anderson, and Romain Veyrune |
| Position | Deputy Division Chief/Research Assistant/Economist in the IMF's Monetary and Capital Markets Department |
| Pages | 42-43 |
Page 42
WHETHER he knows it or not, the owner of a Pacific island surfboard shop thinking in March about the cost of buying 100 surfboards from his California supplier in July should care about his country's exchange rate regime. A country's exchange rate regime governs its exchange rate-that is, how much its own currency is worth in terms of the currencies of other countries. If the surfboard shop owner's country has a fixed exchange rate regime, under which the value of the local currency is tied to that of the U.s. dollar, then he can be confident that the price of surfboards in his currency won't change over the coming months. By contrast, if his country has a flexible exchange rate regime vis-à-vis the U.s. dollar, then its currency could go up or down in value during the change of seasons and he may want to allocate more, or less, local currency for his forthcoming surfboard purchase.
If you extend the above scenario to all cross-country transactions, you can see that the exchange rate regime has a big impact on world trade and financial flows. And the volume of such transactions and the speed at which they are growing highlight the crucial role of the exchange rate in today's world, thereby making the exchange rate regime a central piece of any national economic policy framework.
Exchange rate regimes are typically divided into three broad categories. At one end of the spectrum are hard exchange rate pegs. these entail either the legally mandated use of another country's currency (also known as full dollarization) or a legal mandate that requires the central bank to keep foreign assets at least equal to local currency in circulation and bank reserves (also known as a currency board). Panama, which has long used the U.s. dollar, is an example of full dollarization, and Hong Kong sAR operates a currency board.
Hard pegs usually go hand in hand with sound fiscal and structural policies and low inflation. they tend to remain in place for a long time, thus providing a higher degree of certainty for pricing international transactions. However, the central bank in a country with a hard exchange rate peg has no independent monetary policy because it has no exchange rate to adjust and its interest rates are tied to those of the anchor-currency country.
In the middle of the spectrum are soft exchange rate pegs- that is, currencies...
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