Shock persistence and the choice of foreign exchange regime - an empirical note from Mexico
AbstractThe academic and policy debate about optimal foreign exchange rate regimes for emerging economies, has focused more on the theoretical costs and benefits of possible regimes, than on their actual performance. The authors report on what can be called exchange-rate-regime-dependent differential shock persistence - that is, the time output takes to return to its trend after a negative shock - in a sample of countries representing various points on the spectrum of nominal foreign exchange flexibility. They find strong evidence that Mexico's stimulated output recovery after a negative external shock was faster (a third as long) when the country's policymakers let the nominal foreign exchange rate float, than when they fixed it, and much faster than in other developing countries that kept nominal foreign exchange rates constant, especially those that resorted to currency board arrangements to support that constancy. These results are insufficient to guide the choice of regime (they lack general equilibrium value, and are based on a limited sample of countries), but they highlight an important practical consideration in making that choice: How long it takes for output to adjust after negative shocks, is sensitive to the level of rigidity of the foreign exchange regime. This factor may be critical when the social costs of those adjustments are not negligible.
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Bibliographic InfoPaper provided by The World Bank in its series Policy Research Working Paper Series with number 2371.
Date of creation: 31 Jul 2000
Date of revision:
Fiscal&Monetary Policy; Economic Theory&Research; Payment Systems&Infrastructure; Environmental Economics&Policies; Banks&Banking Reform; Economic Stabilization; Macroeconomic Management; Economic Theory&Research; Fiscal&Monetary Policy; Environmental Economics&Policies;
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