Toward a Stable System of Exchange Rates: Implications of the Choice of Exchange Rate Regime

This paper conducts a comprehensive empirical analysis to examine the stability of the overall system of exchange rates along two dimensions: does the choice of exchange rate regime help individual countries achieve their domestic macroeconomic goals? And does this choice of regime facilitate the country’s interaction with the rest of the system? The empirical findings suggest that there is no universally “right” regime—pegged and intermediate regimes are associated with low nominal volatility and higher economic growth, especially for emerging market economies, and with deeper trade integration, which is growth enhancing. However, floating regimes imply a smoother external adjustment and lower susceptibility to financial crises. Individual countries should therefore tailor the choice of exchange rate regime according to their particular economic challenges, with the proviso that those opting for less flexible regimes should ensure strong macroeconomic fundamentals to minimize the risk of (potentially contagious) crises. This paper should not be reported as representing the views of the IMF. The views expressed here are those of the authors and do not necessarily represent those of the IMF or IMF policy. JEL Classification Numbers: F31, F40