Big and small currencies: The regional connection

Abstract

Agnès Bénassy-Quéré and Benoît Cœuré INTRODUCTION It is now widely recognized that the liberalization of capital flows casts doubts on the sustainability of the so-called ‘intermediate’ or ‘middle-ofthe road’ exchange rate regimes, that is of those regimes lying in between free floating, and hard pegs (currency boards, full dollarization or currency unions). This new consensus follows the currency crises experienced in Europe and in a number of emerging countries throughout the 1990s. This is the ‘two-corner approach’ to the choice of exchange rate regimes (see for instance Eichengreen, 1994; Fisher, 2001). Indeed a number of policy moves have followed this approach. A number of countries have rejected intermediate regimes in favour of one or the other of the ‘corner’ solutions. The European exchange rate mechanism gave way to the euro; full dollarization was undertaken in Ecuador; and various countries such as Brazil, Russia and some Asian countries moved to free floats. Reality is mixed however. The breakdown of the Argentine currency board at the end of 2001 has shown that hard pegs can be vulnerable too. At the other range of the spectrum, a series of empirical studies have shown that most countries with officially floating exchange rates do in fact intervene on foreign exchange markets to stabilize their currencies. In this chapter, we argue that the two-corner approach omits a crucial dimension of exchange rate regimes: the regional dimension. Hard pegs can fail when they are not consistent with other regimes in the….