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Regime-switching in exchange rate policy and balance sheet effects


  • Fiess, Norbert
  • Shankar, Rashmi


The authors apply regime-switching methods to a monetarist model of exchange rates and identify well-defined intervention policy cycles. The policy response indices include a standard exchange market pressure-based index and a model-based volatility ratio that is endogenized relative to Japan, assumed to be a"benchmark"floater. The authors find strong evidence that balance sheet effects, proxied by the stock ratio of external liabilities to assets, and economic performance, as measured by GDP and stock market indices, determine the cost of the regime shift. They use a panel of quarterly data from 1985 to 2004 for a sample of 15 countries, mostly in East Asia and Latin America.

Suggested Citation

  • Fiess, Norbert & Shankar, Rashmi, 2005. "Regime-switching in exchange rate policy and balance sheet effects," Policy Research Working Paper Series 3653, The World Bank.
  • Handle: RePEc:wbk:wbrwps:3653

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    References listed on IDEAS

    1. Bazdresch, Santiago & Werner, Alejandro, 2005. "Regime switching models for the Mexican peso," Journal of International Economics, Elsevier, vol. 65(1), pages 185-201, January.
    2. Reinhart, Carmen & Calvo, Guillermo, 1999. "Inversión de las corrientes de capital, tipo de cambio y dolarización
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    3. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters,in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
    4. Engel, Charles, 1994. "Can the Markov switching model forecast exchange rates?," Journal of International Economics, Elsevier, vol. 36(1-2), pages 151-165, February.
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    6. Dooley, Michael P, 2000. "A Model of Crises in Emerging Markets," Economic Journal, Royal Economic Society, vol. 110(460), pages 256-272, January.
    7. Roberto Chang & Andrés Velasco, 2000. "Liquidity Crises in Emerging Markets: Theory and Policy," NBER Chapters,in: NBER Macroeconomics Annual 1999, Volume 14, pages 11-78 National Bureau of Economic Research, Inc.
    8. Frommel, Michael & MacDonald, Ronald & Menkhoff, Lukas, 2005. "Markov switching regimes in a monetary exchange rate model," Economic Modelling, Elsevier, vol. 22(3), pages 485-502, May.
    9. Owyang, Michael T. & Ramey, Garey, 2004. "Regime switching and monetary policy measurement," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1577-1597, November.
    10. Luis Felipe Céspedes & Roberto Chang & Andrés Velasco, 2004. "Balance Sheets and Exchange Rate Policy," American Economic Review, American Economic Association, vol. 94(4), pages 1183-1193, September.
    11. Roberto Chang & Andres Velasco, 2004. "Monetary Policy and the Currency Denomination of Debt: A Tale of Two Equilibria," CID Working Papers 106, Center for International Development at Harvard University.
    12. Sweder van Wijnbergen, 1991. "Fiscal Deficits, Exchange Rate Crises and Inflation," Review of Economic Studies, Oxford University Press, vol. 58(1), pages 81-92.
    13. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September.
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    17. Guillermo A. Calvo, 1998. "Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops," Journal of Applied Economics, Universidad del CEMA, vol. 1, pages 35-54, November.
    18. repec:rus:hseeco:124089 is not listed on IDEAS
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    Cited by:

    1. Walter, Stefanie, 2008. "A New Approach for Determining Exchange-Rate Level Preferences," International Organization, Cambridge University Press, vol. 62(03), pages 405-438, July.

    More about this item


    Economic Theory&Research; Economic Stabilization; Macroeconomic Management; Fiscal&Monetary Policy; Banks&Banking Reform;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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