Middle And Bipolar Exchange Rate Regime Choice: Determinants And Hypothesis Testing

Since the nineteenth century, there's been an ongoing debate between the merits of fixed exchange rates and those of floating exchange rates. It's a debate that more recently has evolved into one between intermediate and "two poles" exchange-rate regimes, the latter being the two extremes of fixed and floating. The debate has gained fresh vigour since the series of financial and monetary crises in some emerging market countries during the late 1990s.These crises saw the emergence of a new consensus among economists; a view that the growth of capital mobility in the global financial markets has forced some countries to abandon pegged exchange rates. Some economists predict that as capital mobility grows in these countries, so they will gravitate towards either free-floating exchange rates or a super-fixed exchange-rate regime, such as monetary union, formal dollarization or a currency board.The new consensus, however, has not been subjected to statistical analysis. More importantly, it does not explain why some emerging-market countries can hold exchange-rate pegs for longer than others, despite a similar level of exposure to external economic influences and a comparable economic environment.To explore the theory behind different exchange-rate regimes and examine the validity of "the hypothesis of the vanishing intermediate regime," I have studied both traditional theories and the latest developments in this field. By reviewing the key points made, I argue that the hypothesis is flawed, because many developing countries are constrained to a choice between the "two poles," neither of which are suitable. I argue that these constraints may be the part of reason why some developing countries haven't given up exchange-rate pegs, instead opting for one of the "two poles."But I believe there are other factors that influence the choice of exchange-rate regime -factors that have not been addressed in economic literature to date. These factors are the primary focus of my thesis.Furthermore, my study shows that several factors, both institutional and relating to market structure, have received insufficient attention from economists, and these factors in turn offer reasons why some countries hold exchange-rate pegs for longer than others. The factorsinclude financial intermediation and central bank independence, along with political democracy and transparency. Based on these ideas, I have developed three hypotheses:Middle-income countries with bank-credit financial systems are more likely to choose or maintain intermediate exchange-rate regimes;Middle-income countries with independent central banks are more likely to choose or maintain intermediate exchange-rate regimes; Middle-income countries with a lower level of political democracy and transparency are more likely to choose or maintain intermediate exchange-rate regimes.In the empirical section of my thesis, a parallel data set of 50 countries for the period 1986-2001 is used to estimate a series of Logit models, with a binary exchange-rate regimes index as the dependent variable. The test results support the hypotheses in the theoretical discussion.From my test results, I made the following conclusions:Capital mobility influences the choice of exchange-rate regime, but it is neither the only factor nor the critical one in any decision-making process. This provides more evidence to suggest the "vanishing intermediate regime" hypothesis, which is based on the phenomenon of international capital mobility growth, is flawed. More importantly, institutional and structural factors, discussed in the theoretical section, are clearly evident in government exchange-rate regime decisions. These help to show why some countries choose to maintain or adopt intermediate regimes while capital mobility grows in the global financial market.