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Liberalized Markets Have More Stable Exchange Rates; Short-Run Evidence From Four Transition Countries

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  • Ales Bulir

Abstract

The paper looks at the hypothesis that financial market liberalization can create a basis for more stable exchange rates, as deviations of exchange rates from equilibrium levels bring forth stabilizing flows of liquidity. This "endogenous liquidity" hypothesis suggests that opening financial markets militates in favor of exchange rate flexibility by increasing the viability of a floating regime, as well as making it more difficult to maintain a peg. The paper examines this hypothesis in a sample of four transition economies and finds that exchange rates tend to return faster to their Hodrick-Prescott-based values where markets are liberalized. The results suggest that early and successful foreign exchange liberalization pays off in terms of depth of the market and, hence, faster adjustment of exchange rate to shocks. Moreover, it implies that central banks should not be overly concerned with short-run volatility of their national exchange rates, given the self-correcting tendencies.

Suggested Citation

  • Ales Bulir, 2004. "Liberalized Markets Have More Stable Exchange Rates; Short-Run Evidence From Four Transition Countries," IMF Working Papers 04/35, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:04/35
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    References listed on IDEAS

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    Cited by:

    1. Juraj Stanèík, 2007. "Determinants of Exchange-Rate Volatility: The Case of the New EU Members," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 57(9-10), pages 414-432, October.
    2. Gilda C Fernandez & Cem Karacadag & Rupa Duttagupta, 2004. "From Fixed to Float; Operational Aspects of Moving towards Exchange Rate Flexibility," IMF Working Papers 04/126, International Monetary Fund.

    More about this item

    Keywords

    Nonlinearity; Foreign exchange; Exchange rate; endogenous liquidity; error-correction mechanism; exchange rates; random walk; kurtosis; International Monetary Arrangements and Institutions;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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