You are on page 1of 20

DOES THE CHOICE OF EXCHANGE RATE

REGIME AFFECT THE ECONOMIC GROWTH


OF DEVELOPING COUNTRIES?

Glauco De Vita
Khine Sandar Kyaw*
Oxford Brookes University, UK

ABSTRACT

This paper revisits, empirically, the question of whether the choice of exchange rate regime
(floating currency, fixed rate or intermediate arrangement) has a direct effect on the long-
term growth of developing countries. We use fixed effects panel estimation on a relatively
large sample of 70 developing countries for the period 1981 to 2004. In addition to
controlling for the level of income of these economies, we draw from alternative exchange
rate regime classification schemes and account for the presence of an explicit monetary
anchor to characterize policy. Our results indicate the absence of any robust relation
between the choice of exchange rate regime and economic growth. The policy implication
of these findings is clear. The choice of exchange rate policy has no direct impact on the
long-term growth of developing countries.

JEL Classifications: O10, F31
Keywords: Exchange Rate Regimes, Economic Growth, Developing Countries
Corresponding Authors Email: gde-vita@brookes.ac.uk

INTRODUCTION

Over the past decade, the question of the choice of exchange rate regime and the
macroeconomic consequences of this choice, has received considerable attention. In
addition to effects on trade flows (Rose, 2000; Rose and van Wincoop, 2001; Frankel and
Rose, 2002; Glick and Rose, 2002; Rose and Stanley, 2005; Klein and Shambaugh, 2006;
Adam and Cobham, 2007; etc.), recent literature identifies empirical regularities between
exchange rate regimes and national price levels (Ghosh et al., 2002; Broda, 2006), the
transmission of terms of trade shocks (Broda, 2004; Edwards and Levy-Yeyati, 2005), and
foreign direct investment flows (Schiavo, 2007; Abbott and De Vita, 2008). In this paper,
interest centers on the relationship between exchange rate regimes and economic growth,
with a focus on the impact of the choice of regime on the long-term growth of developing
countries.
At the theoretical level, the traditional view of the neutrality of money suggests
that the exchange rate regime should be unimportant for long-term growth performance.
Nevertheless, the literature highlights several mechanisms through which a link can be
established. The first of such mechanisms can be traced back to the work of Milton
Friedman (1953) who, in his essay on the case for flexible exchange rates, argues that
flexible regimes are better suited to insulate the economy against economic shocks.
Specifically, a flexible regime may foster growth by enabling an economy characterized by
136


nominal rigidities to better absorb and adjust to real domestic and foreign shocks. This
business cycle mitigation mechanism (see Barlevy, 2004) implies that fixed regimes
induce greater output volatility which, in turn, is expected to affect negatively an
economys long-term growth performance (see Ramey and Ramey, 1995; Kneller and
Young, 2001). However, it has also been contended that flexible rates are more prone to
exchange rate shocks, exacerbating business cycles and dampening growth compared to a
fixed regime, especially in the context of developing economies with a weak financial
system (Bailliu et al., 2003). Although credibility arguments in favor of fixed exchange
rates point to the reduction of a countrys vulnerability to speculative currency attacks and
to greater stability as factors conducive to stronger growth performance (see Calvo and
Vegh, 1994; and Mundell, 1995), the real interest rate costs associated with the need to
defend a peg in the event of a negative external shock, and the consequent uncertainty as to
the sustainability of such a regime, are generally considered to be deleterious to growth.
The theoretical ambiguity as to the sign of the relationship between exchange rate
regimes and economic growth is compounded by the multiplicity of indirect channels
through which exchange rate regimes could affect growth. These include the rate of
physical capital accumulation (e.g. Aizenman, 1994), the degree of openness to capital
flows (Bailliu, 2000) and the level of financial development (Levine, 1997; Aizenman and
Hausmann, 2000; Flandreau and Bordo, 2003; Aghion et al., 2006). Whilst this literature
posits mostly positive indirect effects of fixed exchange rates on growth over the long run,
conflicting predictions as to the growth effects of other key variables that are likely to be
influenced by the choice of regime type accentuate the theoretical controversy. For
example, increased trade has not always been found to have a positive influence on
economic growth (see Slaughter, 2001). Similarly, while within traditional Solow-type neo-
classical growth models the assumption of diminishing returns to physical capital means
that foreign direct investment (FDI) could at best affect the level of income, with no impact
upon the long run growth rate, the advent of endogenous growth theory (Barro and Sala-i-
Martin, 1995) has spurred a new wave of growth-theoretic models in which FDI induces
permanent increases in the rate of output growth in so far as it generates increasing returns
in production via externalities and productivity spillovers (see De Mello, 1997).
Against this theoretical backdrop, it should come as no surprise that the onus of
resolving the question of whether or not there exists a link between exchange rate regimes
and growth has fallen upon empirical research. However, to date, empirical work has
produced mixed results from which to discern a conventional wisdom is equally difficult.
Our contribution adds to this literature in several respects. First, using the best
available data for a relatively large panel, we control for most of the variables identified in
the empirical growth literature and, drawing on recent advances in the classification of
exchange rate regimes, we employ two de facto regime classification schemes to construct
the exchange rate regime dummies in addition to the official scheme reported by the IMF.
Second, we augment the level of regime aggregation (traditionally based on the three-way
classification of fixed, intermediate and flexible rates) by additionally controlling for the
monetary policy characterizing the choice of exchange rate regime through further
disaggregation between intermediate and flexible rates with and without a nominal policy
anchor. Finally, although previous findings suggest that the growth performance of
alternative regimes depends on the maturity of member countries (Levy-Yeyati and
Sturzenegger, 2003), of their institutions (Bailliu et al., 2003; Husain et al., 2005), and on
137


their degree of involvement in international financial markets (Jadresic et al., 2001), no
attempt has been made in earlier literature to estimate the relationship between exchange
rate regimes and growth within a framework disaggregated according to the level of
income of developing countries. In this paper, we discriminate empirically across different
levels of economic development by stratifying our sample of 70 developing countries
according to three distinct income level categories, namely low-, lower middle- and upper
middle-income countries.
The remainder of this paper is organized as follows. The next section offers a
concise yet comprehensive literature review of empirical work focusing on the impact of
exchange rate regimes on growth. Then we provide a discussion of the exchange rate
regime classifications from which we draw to construct our regime dummies. In the
following section, the model and the data used are described. This is followed by the
presentation and discussion of the estimation results. Finally, the last section draws
conclusions.

A REVIEW OF PREVIOUS EMPIRICAL WORK

Ambiguity at the theoretical level over the relationship between exchange rate regimes and
economic growth is reflected in the empirical work. Ghosh et al. (1997) run growth
regressions for 136 countries over the period 1960-1989. They controlled for pegged,
intermediate and flexible exchange rate regimes using data drawn from the de jure
classification published by the International Monetary Fund (IMF) and found no significant
differences in growth rates across the exchange rate regimes examined. This result is
broadly confirmed in Ghosh et al. (2002) where the sample period extends from 1970 to
1999 and the endogeneity of the regime is controlled for through a treatment effects model.
Since failure to capture the extent to which actual exchange rate policy conforms
to countries declared commitment to the announced regime can lead to measurement error
(Calvo and Reinhart, 2002), Levy-Yeyati and Sturzenegger (2003) (henceforth LYS)
compile a de facto exchange rate regime classification to examine the link between
exchange rate regimes and growth for a large sample of countries over the period 1974-
2000. They find that while for industrial countries the regime type does not have any
significant impact on growth, for developing countries, less flexible (fixed and
intermediate) regimes are significantly associated with slower growth. These results prove
robust to several alternative specifications (pooled annual data, pooled five-year data and
cross-sectional regressions) and pass a number of sensitivity checks.
Working with a panel of 60 industrialized and developing countries over the 1973-
98 period, Bailliu et al. (2003) examine the impact of exchange rate regime on growth by
means of dynamic GMM estimation. In addition to the traditional tripartite scheme of
regime aggregation (flexible, fixes and intermediates) they use an expanded one which
further distinguishes between intermediate and floating regimes based on the presence of a
nominal policy anchor. In each case, the exchange rate regime is classified according to
both the de jure classification, and a de facto classification of their own construction that
corrects for observed volatility in the actual behavior of the exchange rate. They find that a
pegged regime is positively linked to growth, an intermediate regime without an anchor is
negatively associated with growth, and all other regime types have no discernible impact
on growth.
138


Husain et al. (2005) estimate (with and without fixed country effects) exchange
rate regime durability and performance across a large panel of advanced, emerging and
developing economies over the period 1970-1999. They find that in developing countries
more flexible regimes are associated with high inflation but do not lead to gains in
economic growth while fixed or near fixed regimes deliver lower inflation without
sacrificing growth.
Miles (2006) replicates the LYS growth regressions with a panel of annual data
(1976-2000) across a developing countries subset of the LYS original sample. The
innovation here consists in the inclusion of a measure of the black market premium on
foreign exchange, a variable meant to capture macroeconomic imbalances. His results
indicate that once such a measure of domestic distortions is added to the model, exchange
rate regimes exert no independent impact on the economic growth of developing countries.
More recently, Bleaney and Francisco (2007) use the official (IMF) and four
alternative de facto exchange rate regime classifications to examine the relationship with
inflation and growth in 91 developing countries over the period 1984-2001. With the
exception of the results obtained from the Reinhart and Rogoff (2004) regime
classification, which produce quite unfavorable outcomes for flexible regimes (higher
inflation and lower growth), their estimates across the other classification schemes suggest
that floats have very similar growth rates to soft (easily adjustable) pegs while hard pegs
(currency unions and currency boards) have slower growth than other regimes (though the
latter result may by their own admission be due to fixed country effects). However, it
should be noted that they only include a few growth determinants in their regressions, and
do not attempt to control for endogeneity.
Evidently, the conflicting evidence warrants further empirical research.

CLASSIFYING EXCHANGE RATE REGIMES: ISSUES AND SCHEMES

As originally noted by Ghosh et al. (1996:2): Beyond the traditional fixed-floating
dichotomy lies a spectrum of exchange rate regimes. The de facto behavior of an exchange
rate, moreover, may diverge from its de jure classification.
The above quote points to two critical issues that give rise to considerable
measurement difficulties. The first issue is that in a continuum which spans across fixed
rates, hard and soft pegs, crawling or monitoring bands, and floats with heavy, light or no
intervention, it is not clear where one should draw the line (Backus, 2005). To the applied
economist the issue of a fuzzy continuum poses two additional dilemmas: (i) Which degree
of compression should one adopt to aggregate the many fine codes of the original regime
classification schemes into a smaller, empirically tractable, yet informative number of
regime policy options to be examined?; and (ii) Where do the exact boundaries of
intermediate regimes (floating rates but within a predetermined range) lie? These
dilemmas assume even greater significance when one considers that, especially in
developing and emerging markets, countries regimes are often of the intermediate type
(Williamson, 2000). Although it is often contended that intermediate regimes are not
sustainable over the long run, as they lack credibility and make economies more
susceptible to speculative currency attacks and economic crises (Eichengreen, 1994 and
2000; Fischer, 2001; Glick, 2001; Summers, 2000), Williamson (2000) suggests that
intermediate regimes will continue to be seen as a viable option to try to reap the benefits
139


of fixed and flexible rates without having to incur some of their costs. The second issue is
that even between de facto regime classification schemes that purport to measure what the
regime is (rather than what is declared to be), there is a surprisingly low correlation
(Husain et al., 2005; Bleaney and Francisco, 2007). This divergence stems primarily from
differences in the way in which admittedly arbitrary correction rules attempt to adjust for
the bias between countries publicly stated commitment to a given regime and the observed
volatility of the exchange rate. For example, while Levy-Yeyati and Sturzenegger (2003
and 2005) use cluster analysis techniques to group countries regimes on the basis of the
volatility of the exchange rate, of exchange rate changes and of reserves, Bailliu et al.
(2003) develop a two-step mechanical rule whereby countries regimes are grouped
according to a flexibility index for each country based on its degree of exchange rate
volatility relative to the group average for each year. Accordingly, for the sake of
comprehensiveness and for comparative purposes, our analysis draws from three different
regime classification schemes that vary considerably in the way in which they deal with the
above mentioned issues.
The first regime classification that we employ is that published by the IMF in its
Annual Report on Exchange Rate Agreements and Exchange Restrictions (various issues).
Since 1999 the IMF moved from a purely de jure classification based on what countries
report they do, to a hybrid one which combines information based on the IMF officials
informed judgment about the actual behavior of the exchange rate. Despite this, concerns
about the regime classification published by the IMF have prompted researchers to develop
alternative schemes that attempt to characterize more accurately countries de facto
regimes.
The second regime classification from which we draw is the one developed by
Levy-Yeyati and Sturzenegger (2003). As noted earlier, LYS use a de facto classification
that groups countries annual observations according to the behavior of three dimensions of
exchange rate policy: the volatility of the exchange rate relative to the relevant anchor
currency (or basket of currencies); the volatility of exchange rate changes (measured by the
standard deviation of monthly percentage changes); and the volatility of reserves (to
quantify the degree of active intervention). Using cluster analysis, LYS then group
observations into flexible, intermediates, fixed and inconclusive (unclassifiable) regimes
according to the degree of significant variability recorded in each dimension. In spite of its
complexity, this classification too has not escaped criticism on the grounds of a non-trivial
proportion of unclassifiable observations, a large number of recorded regime switches as
well as its inherent inability to distinguish between genuine floats and devaluations due to
extreme inflation, where exchange rates are flexible by necessity.
Finally, we use the Reinhart and Rogoff (2004) (henceforth RR) regime
classification scheme, which by virtue of its characteristics seems particularly suited to deal
with the challenges of the analysis ahead. The RR classification seeks to address potential
misclassification by isolating flexible rates characterized by episodes of very high inflation
(which are often followed by devaluations and tend to be associated with very low growth)
through a separate freely falling category (resulting in a much smaller number of
observations recorded as floats). Another distinguishing feature of the RR classification
lies in the identification of the market-determined exchange rate. This market-determined
exchange rate is defined as either the official rate (where no black market premium exists),
the parallel rate (if market-determined), or the black market exchange rate, where/when it
140


exists. This definitional aspect is particularly important in the context of the present
analysis since the black market premium on foreign exchange was already used by Miles
(2006) as a measure of macroeconomic imbalances and, as noted earlier, he found that its
inclusion in the growth equations left no significant independent effect of exchange rate
regimes. Finally, the RR classification employs a more stable rolling five-year horizon that
better captures the longer-term regimes (rather than just picking up transient regime shifts
or short-term spells within a regime) and, in so doing, is likely to be more suitable for the
analysis of long term economic growth.
The use of the above exchange rate regime classification schemes to define fixed,
intermediate and floating rates, is necessary but not sufficient to properly represent policy.
While a fixed exchange rate regime represents a coherent monetary order (see Laidler,
1999), without further information, knowledge that the regime is flexible or intermediate is
not enough to characterize policy. This is because, as Bailliu et al. (2003) point out,
flexible and intermediate regimes simply define the exchange rate arrangement and are not
informative about the framework in which monetary policy is conducted. For this reason,
we later supplement the information on the regime type by further disaggregating the
sample according to the monetary policy pursued by countries adopting flexible and
intermediate regimes.

MODEL AND DATA

The basic econometric model used in our regression is as follows:

t i i t t i t i t i
y
, , , ,
c o qk |_ + + + + = (1)
where the dependent variable,
t i
y
,
, is the growth rate of real per capita GDP in country i
at time t,
t i,
_ is a vector of explanatory variables,
t i,
k is a vector of exchange rate
regime dummies,
t
are time specific effects,
i
o are country specific effects,
t i,
c are
error terms and the | s and q s are parameters to be estimated. The estimators are also
designed to incorporate individual effects and time effects (Greene, 2008) to handle the
systematic tendency of
t i,
c to be higher for some individual countries than for others and
possibly higher for some time periods than for others. Although our selection of
countries was constrained by data availability, particularly with respect to exchange rate
regimes data, we were able to use annual data for 70 developing countries from 1981 to
2004. The full list of countries in our sample is reported in Table 1. Further details on the
definition of the variables and data sources are provided in Table 2.
For each classification scheme, we create dummies for flexible (FLEX),
intermediate (INTER) and fixed regimes (the latter used as the default benchmark). We
then augment the standard tripartite scheme of regime aggregation by further distinguishing
between flexible and intermediate regimes with and without a (nominal) policy anchor.
The International Financial Statistics (IFS) provides information on the monetary policy
framework for many countries, including data on the presence of a publicly announced
nominal anchor in the form of an exchange rate anchor, a monetary target, or an inflation
target.

141


TABLE 1. COUNTRIES GROUPED BY INCOME LEVEL

Low Income Lower Middle Income Upper Middle Income

Cote d'Ivoire Albania Argentina
Gambia Algeria Botswana
Ghana Armenia Brazil
Haiti Bolivia Bulgaria
Kenya Cameroon Chile
Liberia China Costa Rica
Madagascar Colombia Gabon
Malawi Congo, Rep. Jamaica
Mozambique Dominican Republic Latvia
Nigeria Ecuador Kazakhstan
Niger Egypt, Arab Rep. Lithuania
Pakistan El Salvador Malaysia
Senegal India Mexico
Tanzania Guatemala Panama
Togo Honduras Poland
Uganda Indonesia Romania
Zambia Iran, Islamic Rep. Russian Federation
Zimbabwe Jordan Slovak Republic
Moldova South Africa
Mongolia Turkey
Morocco Uruguay
Nicaragua Venezuela, RB
Paraguay
Peru
Philippines
Sri Lanka
Syrian Arab Republic
Thailand
Tunisia
Ukraine
Note: For the income level categorization we used the 2002 per capita GNI income categories calculated by
means of the most recent World Bank Atlas method.

142


TABLE 2. DEFINITION OF VARIABLES AND SOURCES

Variable Description Source

RPCG
Rate of growth of real per capita GDP World Bank, World Development
Indicators (WDI).
INVT Investment as percentage of GDP World Bank, WDI.
IGDP Initial per capita GDP World Bank, WDI.
GC(-1) Lagged government consumption as a percentage of GDP World Bank, WDI.
POPG Population growth in annual percent World Bank, WDI.
EDN Proportion of the population aged 25 and over that has a tertiary
education qualification
Barro and Lee (2001)
TRD Total trade (sum of exports and imports) as a percentage of GDP World Bank, WDI.
INFL(-1) Lagged annual percentage change in the GDP deflator World Bank, WDI.
PCR Private sector credit as a percentage of GDP World Bank, WDI.
BCS Dummy variable for banking crisis Bank of England.
PST Index of government stability that measures the ability of a
government to carry out its declared program(s) and its ability to
stay in office

Political Risk Services.
DHIC Dummy variable for highly indebted countries World Bank, WDI.
ADAPE Dummy variable for South and East Asia and the Pacific

World Bank, WDI.
ADLAC Dummy variable for Latin America and the Caribbean

World Bank, WDI.
ADMA Dummy variable for Middle East, and North and Sub-Saharan
Africa

World Bank, WDI
Exchange
rate
regime
dummies
Equals one for each of the classifications defined IMF Annual Report (1981-2005);
Levy-Yeyati & Sturzenegger
(2005); Reinhart & Rogoff
(2004).



143



In addition to the exchange rate regime dummies, many factors identified in the empirical
growth literature (e.g., Levine and Renelt, 1992) are accounted for. Furthermore, to
control for the possibility that countries with considerable macroeconomic problems may
self-select into choosing fixed exchange rates, we add measures of poor macroeconomic
performance as well as dummies for banking crises and for highly indebted countries.
Regional dummies are also included in the model to control for a potential skew in the
regional distribution of floating observations. As recently noted by Bleaney and
Francisco (2007), de facto exchange rate regime classifications, particularly the RR
classification scheme, may have a bias due to a considerably low proportion of floats in
East and South Asia (the fastest-growing region) and a very high proportion in the
slowest-growing one (sub-Saharan Africa).


RESULTS

The annual rate of GDP growth averaged 1.2 percent over our sample, with noticeable
differences in various exchange rate regimes. As shown in Table 3, a preliminary pass at
the data suggests that countries with intermediate exchange rates had higher average
growth rates than those fixing or pegging their currency under all three classification
schemes. Intermediate regimes also seem to outperform floaters under both the IMF and
RR classifications (the average growth rates drop from 3.6 and 1.9 percent to 0.7 and 1.1
percent, respectively) though, according to the LYS classification scheme, floating
exchange rates have an average growth rate 0.2 percent higher than intermediates. As
shown in Table 4, this overall pattern emerges mainly because of the upper middle-
income countries, where intermediate regimes have higher average growth rates.
However, both the de facto regime classification schemes indicate that for low-income
countries, growth was somewhat higher under a fixed regime. The fact that developing
countries with intermediate regimes have higher average growth, does not in itself mean
that an intermediate regime causes higher growth in these countries. Causality issues
aside, it is first necessary to investigate whether a statistically significant association can
be established.
Table 5 reports the results of estimating our baseline equation for the various
classification schemes. Although we report the estimated coefficients for all the variables
included in our specification, our interest inevitably centres upon the interpretation of the
regime dummies. The INTER and FLEX dummies compare average growth rates for
intermediate and flexible regimes with those of the omitted (benchmark) category of
fixed rates. Although under the IMF classification scheme neither of the differential
regime dummies is statistically significant, according to both of the de facto classification
schemes (the RR and LYS classifications), the intermediate regime dummy has a positive
and significant coefficient (of 0.05 and 0.08, respectively). But do these results hold to
our augmented specification that distinguishes between different monetary policy
frameworks for intermediate and floating regimes? Table 6 reveals that once the
presence of a nominal policy anchor is controlled for, the coefficients of all regime
dummies (INTER and FLEX with and without an anchor), turn insignificant, a result
consistent across all exchange rate classifications.
144


TABLE 3. AVERAGE RATES OF REAL PER CAPITA GDP GROWTH (1981-
2004)

Exchange Rate Regimes

Fixed Exchange
Rate Regime
Intermediate Regime Float
IMF classification
Observations

-0.16 (0.53)
515
3.57 (2.27)
394
0.75 (1.43)
354
RR classification
Observations
1.74 (1.42)
326
1.91 (2.21)
583
1.09 (1.82)
186

LYS classification
Observations
0.95 (1.27)
532
1.36 (0.58)
372
1.60 (2.19)
353

Note: Since average growth rates may be overly sensitive to extreme values stemming from
extraordinary growth volatility (due, for example, to periods of wars), we also report, in
parentheses, the medians.




























145


TABLE 4. AVERAGE RATES OF REAL PER CAPITA GDP GROWTH
DISAGGREGATED BY INCOME GROUPS


IMF Classification

Fixed Exchange
Rate Regime
Intermediate
Regime
Float
Low income

Observations
0.59
(-1.06)
189
1.10
(1.77)
97
1.65
(1.41)
116
Lower middle
income
Observations
-0.92
(1.05)
216
3.32
(2.38)
182
0.68
(1.62)
156
Upper middle
income
Observations
-0.63
(2.24)
110
4.67
(2.21)
115
-0.34
(1.09)
82

Reinhart and Rogoff Classification

Fixed Exchange Rate
Regime

Intermediate
Regime
Float
Low income

Observations
2.35
(-0.22)
155
1.38
(1.24)
143
0.54
(0.90)
73
Lower middle
income
Observations
1.85
(2.83)
89
1.96
(2.28)
293
1.42
(3.14)
61
Upper middle
income
Observations
0.36
(1.58)
82
2.29
(3.35)
147
2.03
(1.73)
52

Levy-Yeyati and Sturzenegger Classification

Fixed Exchange
Rate Regime

Intermediate
Regime
Float
Low income

Observations
1.31
(-0.14)
225
0.57
(0.54)
89
0.89
(1.67)
91
Lower middle
income
Observations
1.08
(1.95)
176
0.66
(1.15)
168
1.07
(2.05)
160
Upper middle
income
Observations
0.32
(2.61)
131
3.96
(-1.68)
115
2.68
(3.54)
102

Note: Figures in parentheses are the medians.


146


TABLE 5. BASELINE GROWTH REGRESSION

Variable

IMF

Reinhart & Rogoff

Levy-Yeyati &
Sturzenegger

INVT 0.02
(1.75)
0.02
(0.69)
0.07
(1.82)
IGDP -0.78
(-1.92)
-0.55
(-1.87)
-0.81*
(-2.45)
GC(-1) -0.01
(-1.46)
-0.00
(-1.84)
-0.01**
(-2.86)
POPG 0.04
(1.83)
0.06*
(1.97)
0.04
(1.67)
EDN 0.01*
(2.17)
0.01**
(2.77)
0.01*
(2.34)
TRD 0.01*
(1.96)
0.03
(1.78)
0.08*
(2.26)
INFL(-1) -0.91
(-1.18)
-0.82
(-0.82)
-1.20*
(-2.37)
PCR -0.11
(-0.63)
-0.09
(-1.68)
-0.86
(-0.98)
BCS -1.30
(-1.82)
-0.28
(-1.43)
-1.00
(-1.73)
PST -0.01
(-0.53)
-0.01
(-1.75)
-0.01
(-0.32)
DHIC 0.00
(1.26)
0.00
(1.18)
0.00
(0.76)
ADAPE -0.01*
(1.98)
-0.05
(-1.41)
-0.06
(-1.92)
ADLAC -0.02
(-1.24)
-0.02
(-1.28)
-0.01
(-1.10)
ADMA -0.08
(-1.59)
0.07
(1.32)
0.05
(0.82)
INTER 0.03
(1.38)
0.05*
(2.25)
0.08**
(2.61)
FLEX 0.03
(1.46)
-0.02
(-0.47)
0.03
(1.73)
Observations
R
2

1263
0.2538
1095
0.3032
1257
0.3729
Note: Figures in parentheses are t ratios obtained from robust standard errors adjusted for
heteroscedasticity and serial correlation using the Newey-West technique (Newey and West, 1987).
The adjusted R-squared statistic was computed by using the technique suggested in Chamberlain
(1982). Year dummies are also included in the regression. ** indicates significance at 1 percent. *
indicates significance at 5 percent.

The results presented in Table 6 may still mask important differences in the
growth performance of alternative regimes and monetary policies across different groups
of developing countries. We therefore re-run growth regressions on a disaggregated
sample, stratified according to the level of economic development of the countries under
examination. As shown in Table 7 (that only reports the regime dummies of interest),
with the sole exception of a significant intermediate regime without an anchor (in low-
147


income countries under the LYS classification, and in lower middle-income countries
under the IMF classification), all other exchange rate arrangements have no statistically
significant differential effect on growth vis--vis the alternative o a fixed exchange rate
regime.

TABLE 6. EXCHANGE RATE REGIMES AND GROWTH REGRESSIONS
CONTROLLING FOR MONETARY POLICY ANCHOR

Variable IMF

Reinhart & Rogoff

Levy-Yeyati &
Sturzenegger

INVT 0.04
(1.94)
0.01
(0.75)
0.08
(0.47)
IGDP -0.80
(-1.87)
-0.49*
(-2.29)
-0.79*
(-2.18)
GC(-1) -0.00
(-1.25)
-0.00*
(-1.96)
-0.01**
(-2.94)
POPG 0.04
(1.73)
0.05**
(2.96)
0.05
(1.59)
EDN 0.01*
(2.29)
0.05
(1.63)
0.03*
(2.40)
TRD 0.01**
(2.61)
0.04*
(2.17)
0.07*
(1.96)
INFL(-1) -0.01
(-0.44)
-0.00
(-0.93)
-0.00
(-0.57)
PCR 0.00
(0.87)
0.00
(1.27)
0.01
(0.98)
BCS -0.02*
(-1.96)
-0.62
(-1.59)
-0.81*
(-2.23)
PST -0.02
(-1.18)
-0.02
(-1.30)
-0.02
(-1.09)
DHIC 0.05
(1.10)
0.06
(0.95)
0.06
(0.86)
ADAPE -1.20
(-1.23)
-1.02
(-1.14)
-1.01*
(-2.10)
ADLAC -0.85
(-0.89)
-0.11
(-1.73)
-0.51
(-0.17)
ADMA -1.20
(-1.68)
-0.85
(-1.85)
-0.72
(-1.65)
INTER with anchor -0.03
(-1.32)
-0.03
(-1.12)
-0.01
(-0.39)
INTER without
anchor
-0.02
(-0.91)
-0.02
(-0.96)
-0.03
(-1.08)
FLEX with anchor -0.02
(-0.79)
-0.02
(-0.48)
-0.03
(-1.41)
FLEX without
anchor
0.00
(0.57)
-0.05
(-0.23)
0.00
(0.93)
Observations
R
2


1263
0.4162
1095
0.4295
1257
0.4852
Note: Figures in parentheses are t ratios obtained from robust standard errors adjusted for heteroscedasticity
and serial correlation using the Newey-West technique (Newey and West, 1987). The adjusted R-squared
statistic was computed by using the technique suggested in Chamberlain (1982). Year dummies are also
included in the regression. ** indicates significance at 1 percent. * indicates significance at 5 percent.


148


The analysis would be incomplete without a formal check on potential regime
endogeneity problems. With this aim in mind, we re-run the regressions using a system
generalized methods-of-moments (SYS-GMM) estimation technique. SYS-GMM
estimation not only exploits the time series variation in the data while accounting for
unobserved country specific effects, it also allows to control for both a possible
correlation between the regressors and the error term, and endogeneity bias.
i
The results
of this exercise (available from the authors upon request) do not change the conclusions
reached heretofore.
ii


TABLE 7. EXCHANGE RATE REGIMES AND GROWTH ESTIMATIONS BY
INCOME GROUPS


IMF
Reinhart &
Rogoff
Levy-Yeyati &
Sturzenegger

Low Income INTER with anchor 0.03
(-1.92)
-0.02
(-1.12)
-0.01
(-0.39)
INTER without
anchor
0.02
(-1.91)
-0.03
(-0.96)
-0.03*
(-2.08)
FLEX with anchor 0.02
(-0.79)
-0.02
(-0.48)
-0.03
(-1.41)
FLEX without anchor
Observations
R
2


0.00
(-0.83)
402
0.3785
0.10
(0.53)
371
0.3870
-0.01
(-1.25)
405
0.4312
Lower
Middle
Income
INTER with anchor 0.02
(1.14)
0.02
(0.48)
0.01
(0.63)
INTER without
anchor
0.03*
(2.23)
0.02
(0.68)
-0.02
(-1.85)
FLEX with anchor 0.04
(1.59)
0.03
(0.67)
-0.01
(-0.31)
FLEX without anchor
Observations
R
2


0.06
(0.96)
554
0.4058
0.01
(0.02)
443
0.4102
0.00
(0.24)
504
0.4512
Upper
Middle
Income
INTER with anchor 0.03
(0.62)
0.02
(0.25)
-0.01
(-0.21)
INTER without
anchor
0.08
(1.29)
0.04
(0.48)
0.07
(1.17)
FLEX with anchor 0.06
(0.84)
0.03
(1.24)
0.08
(1.24)
FLEX without anchor
Observations
R
2

-0.04
(-0.75)
307
0.3551
0.01
(0.98)
281
0.3864
-0.03
(-0.02)
348
0.4258


Note: Figures in parentheses are t ratios obtained from robust standard errors adjusted for heteroscedasticity
and serial correlation using the Newey-West technique (Newey and West, 1987). The adjusted R-squared
statistics were computed by using the technique suggested in Chamberlain (1982). All other control variables
and year dummies are also included in the regression. ** indicates significance at 1 percent. * indicates
significance at 5 percent.

149


How do our result compare with those from previous studies? Although
different country samples and estimation periods make straightforward comparisons
difficult, our results are in stark contrast to those by Levy-Yeyati and Sturzenegger
(2003) who found that, for developing countries, less flexible exchange rate regimes are
associated with slower growth. However, they did not control for the monetary policy
framework that accompanies the regime type. Furthermore, their two-step treatment
effects model to correct for endogeneity problems may in itself introduce a non-linearity
bias in the second stage regression that is likely to result in inconsistent estimates (Miles,
2006; Angrist and Krueger, 2001). Like Bailliu et al. (2003), we find that controlling for
a monetary anchor in the characterization of the policy choice makes a significant
difference in unveiling the independent effect of the regime type. Their results, however,
suggest that more flexible exchange rate regimes with an anchor (jointly considered
flexible and intermediates with anchor) are positively linked to growth, those without an
anchor are negatively linked to growth, and fixed rates have a positive effect on growth.
Nevertheless, their findings are based on a smaller panel (60 countries, of which only 41
class as developing countries, over a time period ending in 1998) and their model
specification accounts for the influence of fewer regressors of interest. Our results are
more in line with those by Ghosh et al. (1997), who found no systematic link between
regime type and growth, Bleaney and Francisco (2007), who found that growth rates in
developing countries are similar under soft pegs and floats (for hard pegs they find it
difficult to distinguish between a regime effect and fixed country effects), and the
conclusion reached by Miles (2006), who found no independent effect of exchange rate
regimes on growth once hard-to-observe policy distortions and macroeconomic
imbalances are accounted for.

CONCLUSION

The paper investigated empirically the question of the impact of exchange rate regime
choice on economic growth using a relatively large panel of developing countries over
the period 1981-2004. The analysis, which further disaggregates the sample of countries
according to their level of economic development, draws on recent advances in exchange
rate regime classification schemes and supplements de jure and de facto regime type data
with information on the monetary policy framework. After controlling for the monetary
framework that accompanies the choice of exchange rate regime, intermediate and
flexible exchange rate arrangements are found not to be more or less pro-growth than the
default regime of a fixed exchange rate. These results, which prove robust to different
estimation techniques and sensitivity checks, hold across exchange rate classification
schemes and apply irrespective of the level of economic development of the developing
countries included in our sample. Notwithstanding the value of the findings uncovered
by the present study, two caveats ought to be borne in mind. First, IFS data are, to date,
the only available source to gauge information on the policy anchor but the reliability of
such data is yet to be confirmed since countries can just as easily misreport this aspect of
policy to the IMF as they could misreport exchange rate policy. Second, although this
paper was exclusively concerned with testing, empirically, whether the choice of
exchange rate regime affects growth, the resulting findings highlight the necessity to
explain, theoretically, why the role of the accompanying monetary policy anchor appears
150


to be particularly important in influencing the relationship of interest. This evidence,
therefore, provides a profitable avenue for future work aimed at the development of
relevant theory.

ENDNOTES

* We are indebted to Andrew Abbott, for his early work in collecting data, and to an anonymous
referee of this journal for helpful comments.
1
Consistency of the SYS-GMM estimates requires evidence of the validity of the chosen
instruments and of significant first order correlation but no higher order serial correlation. The
Hansens J-test (Hansen, 1982) for instrument validity as well as second order serial correlation
tests did not reject the chosen econometric specification which appeared to fit the data well.
2
We also checked whether the results were driven by contamination across regimes due to regime
switches. Specifically, if a regime is not sustained, then it is questionable whether the growth
performance under that regime can be attributed to it. Accordingly, we re-estimated the model
while dropping the first two years following a regime switch and found that this modification did
not alter the results.


REFERENCES

Abbott, A. and G. De Vita, Evidence on the Impact of Exchange Rate Regimes
on Foreign Direct Investment Flows, 2008, ESRC Discussion Paper RES-000-22-2350.
Adam, C. and D. Cobham, Exchange Rate Regimes and Trade, The Manchester
School, 2007, Vol. 75, No. 1, pp.44-63.
Aghion, P., Bacchetta, P., Ranciere, R. and K. Rogoff, Exchange Rate
Volatility and Productivity Growth: The Role of Financial Development. 2006, National
Bureau of Economic Research. NBER Working Paper No.12117.
Aizenman, J., Monetary and Real Shocks, Productive Capacity and Exchange
Rate Regimes, Economica, 1994, Vol. 61, No. 244, pp.407-34.
Aizenman, J. and R. Hausmann, Exchange Rate Regimes and Financial-Market
Imperfections. 2000, NBER Working Paper No. W7738.
Angrist, J. and A. Krueger, Instrumental Variables and the Search for
Identification: From Supply and Demand to Natural Experiments, Journal of Economic
Perspectives, 2001, Vol. 15, No. 4, pp.69-85.
Backus, D.K., Comment on: Exchange rate regime durability and performance
in developing versus advanced economies, Journal of Monetary Economics, 2005, Vol.
52, No. 1, pp.65-68.
Bailliu, J., Private Capital Flows, Financial Development and Economic Growth
in Developing Countries, 2000, Bank of Canada Working Paper No.15.
Bailliu, J., Lafrance, R. and J-F. Perrault, Exchange Rate Regimes and Economic
Growth in Emerging Markets in Revisiting the Case for Flexible Exchange Rates, pp. 317-
45. 2001, Proceedings of a conference at the Bank of Canada, November, Ottawa: Bank of
Canada.
___________________________________, Does Exchange Rate Policy Matter
for Growth?, International Finance, 2003, Vol. 6, No. 3, pp.381-414.
151


Barlevy, G., The Cost of Business Cycles Under Endogenous Growth, American
Economic Review, 2004, Vol. 94, No. 4, pp.964-90.
Bleaney, M. and M. Francisco, Exchange Rate Regime, Inflation and Growth in
Developing Countries: An Assessment, The B.E. Journal of Macroeconomics, 2007, Vol.
7, No. 1, (Topics), Article 18.
Barro, R.J. and X. Sala-i-Martin, Economic Growth, 1995, New York, McGraw-
Hill.
Broda, C., Terms of Trade and Exchange Rate Regimes in Developing
Countries, Journal of International Economics, 2004, Vol. 63, No. 1, pp.31-58.
________, Exchange Rate Regimes and National Price Levels, Journal of
International Economics, 2006, Vol. 70, No. 1, pp.52-81.
Calvo, G. and C. Vegh, Credibility and the Dynamics of Stabilization Policy: A
Basic Framework in Sims C.A. (ed.) Advances in Econometrics: Sixth World Congress,
1994, volume II, Cambridge, CUP.
Calvo, G. and C. Reinhart, Fear of Floating, Quarterly Journal of Economics,
2002, Vol. 117, No. 2, pp.379-408.
Chamberlain, G., Multivariate Regression Models for Panel Data, Journal of
Econometrics, 1982, Vol. 18, No. 1, pp.5-46.
De Mello, L.R. Jr, Foreign Direct Investment in Developing Countries and
Growth: A Selective Survey, The Journal of Development Studies, 1997, Vol. 34, No. 1,
pp.1-34.
Edwards, S. and E. Levy-Yeyati, Flexible Exchange Rates as Shock Absorbers,
European Economic Review, 2005, Vol. 49, No. 8, pp.2079-105.
Eichengreen, B., International Monetary Arrangements for the 21
st
Century,
1994, Washington, Brookings Institution.
Eichengreen, B., Solving the Currency Conundrum, Economic Notes, 2000, Vol.
29, No. 3, pp.313-39.
Fischer, S., Exchange Rate Regimes: Is the Bipolar View Correct?
Distinguished Lecture on Economics in Government, Journal of Economic Perspectives,
2001, Vol. 15, No. 2, pp.3-24.
Flandreau, M. and M.D. Bordo, Core, Periphery, Exchange Rate Regimes, and
Globalization. Globalization in Historical Perspective, 2003, Chicago, University of
Chicago Press.
Frankel, J. and A. Rose, An Estimate of the Effect of Common Currencies on
Trade and Income, Quarterly Journal of Economics, 2002, Vol. 117, No. 2, pp.437-66.
Friedman, M., The Case for Flexible Exchange Rates in Essays in Positive
Economics, 1953, Chicago, University of Chicago Press.
Ghosh, A.R., Gulde, A-M. and H.C. Wolf, Exchange Rate Regimes: Choices and
Consequences, 2002, Cambridge, MIT Press.
Ghosh, A.R., Gulde, A-M., Ostry, J.D. and H.C. Wolf, Does the Exchange Rate
Regime Matter for Inflation and Growth?, 1996, IMF Economic Issues series 2,
September, pp.1-13.
_____________________________________________, Does the Nominal
Exchange Rate Regime Matter? 1997, NBER Working Paper No.5874.
Glick, R., Fixed or Floating? Is it Possible to Manage in the Middle? in de
Brouwer G. (ed.) Financial Markets and Policies in East Asia, 2001, London, Routledge.
152


Glick, R. and A. Rose, Does a Currency Union Affect Trade? The Time-Series
Evidence, European Economic Review, 2002, Vol. 46, No. 6, pp.1125-51.
Greene, W.H., Econometric Analysis, 2008, Upper Saddle River, Prentice Hall.
Hansen, L., Large Sample Properties of Generalized Methods of Moments
Estimators, Econometrica, 1982, Vol. 50, No. 4, pp.1029-54.
Husain, A.M., Mody, A. and K.S. Rogoff, Exchange Rate Regime Durability and
Performance in Developing versus Advanced Economies, Journal of Monetary
Economics, 2005, Vol. 52, No. 1, pp.35-64.
International Monetary Fund (1981-2005) Annual Reports on Exchange Rate
Arrangements and Exchange Restrictions, Washington, International Monetary Fund.
Jadresic, E., Masson, P. and P. Mauro, Exchange Rate Regimes of Developing
Countries: Global Context and Individual Choices, Journal of the Japanese and
International Economies, 2001, Vol. 15, No. 1, pp.68-101.
Klein, M.W. and J.C. Shambaugh, Fixed Exchange Rates and Trade, Journal
of International Economics, 2006, Vol. 70, No. 2, pp.359-283.
Kneller, R. and G. Young, Business Cycle Volatility, Uncertainty and Long-Run
Growth, The Manchester School, 2001, Vol. 69, No. 5, pp.534-52.
Laidler, D., The Exchange Rate Regime and Canadas Monetary Order, 1999,
Bank of Canada Working paper No.7.
Levine, R., Financial Development and Economic Growth: Views and Agendas,
Journal of Economic Literature, 1997, Vol. 35, No. 2, pp.688-726.
Levine, R. and D. Renelt, A Sensitivity Analysis of Cross-Country Growth
Regressions, American Economic Review, 1992, Vol. 82, No. 4, pp.942-63.
Levy-Yeyati, E. and F. Sturzenegger, To Float or to Fix: Evidence on the Impact
of Exchange Rate Regimes on Growth, American Economic Review, 2003, Vol. 93, No. 4,
pp.1173-93.
______________________________, Classifying Exchange Rate Regimes:
Deeds vs. Words, European Economic Review, 2005, Vol. 49, No. 6, pp.1603-35.
Miles, W., To Float or not to Float? Currency Regimes and Growth, Journal of
Economic Development, 2006, Vol. 31, No. 2, pp.91-105.
Mundell, R., Exchange Rate Systems and Economic Growth, Rivista di Politica
Economica, 1995, Vol. 85, No. 6, pp.1-36.
Newey, W.K. and K. West, A Simple Positive Semi-Definite, Heteroskedasticity
and Autocorrelation Consistent Covariance Matrix, Econometrica, 1987, Vol. 55, No. 3,
pp.703-8.
Ramey, G. and V. Ramey, Cross-Country Evidence on the Link between
Volatility and Growth, American Economic Review, 1995, Vol. 85, No. 5, pp.1138-51.
Reinhart, C. and K. Rogoff, The Modern History of Exchange Rate
Arrangements: A Reinterpretation, Quarterly Journal of Economics, 2004, Vol. 119, No.
1, pp.1-48.
Rose, A., One Money, One Market: The Effect of Common Currencies on
Trade, Economic Policy, 2000, Vol. 15, No. 30, pp.8-45.
Rose. A. and T. Stanley, A Meta-Analysis of the Effect of Common Currencies
on International Trade, Journal of Economic Surveys, 2005, Vol. 19, No. 3, pp.347-65.
Rose, A. and E. van Wincoop, National Money as a Barrier to Trade: The Real
Case for Monetary Union, American Economic Review, 2001, Vol. 91, No. 2, pp.386-90.
153


Schiavo, S., Common Currencies and FDI Flows, Oxford Economic Papers,
2007, Vol. 59, No. 3, pp.536-60.
Slaughter, M., Trade Liberalisation and Per Capita Income Convergence: A
Difference-in-Difference Analysis, Journal of International Economics, 2001, Vol. 55,
No. 1, pp.203-28.
Summers, L.H., International Financial Crises: Causes, Prevention and Cures,
American Economic Review, Papers and Proceedings, 2000, Vol. 90, No. 2, pp.1-16.
Williamson, J., Crawling bands or monitoring bands? How to Manage Exchange
Rates in a World of Capital Mobility, International Finance, 1998, Vol. 1, No. 1, pp.59-
79.
___________, Exchange Rate Regimes for Emerging Markets: Reviving the
Intermediate Option, 2000, Washington, Institute for International Economics.



Reproducedwith permission of thecopyright owner. Further reproductionprohibited without permission.

You might also like