DP744 Country Characteristics and the Choice of the Exchange Rate Regime: Are Mini-skirts Followed by Maxis?

Author(s): Seppo Honkapohja, Pentti Pikkarainen
Publication Date: December 1992
Keyword(s): Developing Countries, EMS, Exchange Rate Regime, Export Diversification
JEL(s): F2, F31, F33
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=744

We use a sample of 140 countries to study empirically how a country's characteristics are associated with its choice of an exchange rate regime. When countries are classified according to their current exchange rate arrangements, we observe that small countries with low diversification of exports are the most likely candidates to peg their exchange rates. Other country characteristics, such as the level of development, openness of the real or financial sector, geographical diversification of exports, and fluctuations in the terms of trade, have hardly any power to explain the choice of an exchange rate system. Somewhat surprisingly, it is developing countries which have moved towards more flexible exchange rate practices during the last ten years, while countries with well diversified exports have adopted more rigid exchange rate arrangements. The regression results predict that Italy, Spain and the United Kingdom should have floating exchange rates, while Israel, New Zealand and Switzerland should adopt a more rigid exchange rate regime. Finland should adopt a regime of limited flexibility (such as the EMS) rather than peg to a basket or float.