The author studies whether a consistent peg exchange rate policy has an effect on the occurrence of currency crises. He finds that countries with consistent pegs have a significantly lower probability of currency crises than those with other exchange rate policies.
The author tries to determine whether currency crises are caused or influenced by a consistent peg (CP) exchange rate policy. Controlling for self-selection bias in his study, he concludes that countries that consistently maintain announced pegged regimes can substantially avoid currency crises and speculative currency attacks as a result of the enhanced credibility of their currencies and perceived positive signal regarding the government’s willingness to defend the exchange rate.
How Is This Research Useful to Practitioners?
In a global setting, currency management is an integral part of portfolio management. It is essential for portfolio managers and research analysts to understand exchange rate policies of various countries and their effects on assets.
The author formulates four different hypotheses around the view that countries with a CP exchange rate policy have a significantly lower probability of experiencing a currency crisis than those with other exchange rate policies. The hypotheses explore that view compared with countries that have a fear of announcing a change to a CP policy, countries that cannot implement or fear implementing a CP policy, and countries with a consistent float policy.
He uses the IMF classification to identify official announced exchange rate regimes and the Reinhart and Rogoff (Quarterly Journal of Economics 2004) classification to identify actual exchange rate regimes to find discrepancies. After controlling for self-selection bias using bias-corrected matching estimators, the author statistically confirms that deviations of actual exchange rate regimes from announced regimes significantly affect the probability of a currency crisis occurring.
How Did the Author Conduct This Research?
The study sample consists of data on currency crises and exchange rate regimes from 84 countries for the period of 1980–1998. The author uses bias-corrected matching methods that were recently developed in microeconometric evaluation studies to address the self-selection problem of regime adoption. He then identifies episodes of currency crisis in each country using data from an exchange market pressure index, which is constructed from the weighted average of changes in exchange rates and foreign reserves.
Using matching estimators, the author estimates the average effect of a CP on the occurrence of currency crises. He concludes that consistent pegs significantly reduce the probability of both successful and unsuccessful speculative attacks compared with a policy of adopting an actual peg but not announcing the change. The findings also suggest that countries that actually adopt pegged regimes should announce their adoption of currency pegs if they truly want to avoid speculative attacks.
The author examines the average effect of a CP on the incidence of currency crises and reasonably concludes that countries that consistently maintain announced pegged regimes can substantially avoid speculative attacks and currency crises. The findings defy conventional wisdom that consistent pegs invite higher risk of currency crises and speculative attacks.