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This paper empirically examines the link between de facto exchange rate regimes and the incidence of currency crises in 84 countries from 1980 to 2001 using probit models. We employ the de facto classification of Reinhart and Rogoff (2004) that allows us to estimate the impact of relatively long-lived exchange rate regimes on currency crises with much greater precision. We find no evidence that, as the bipolar view argues, intermediate regimes have a significantly higher probability of currency crises than both hard pegs and free floats. Using the combined data of exchange rate regimes and the existence of capital controls, we also find that hard pegs with capital account liberalization have a significantly lower probability of currency crises than intermediate regimes with capital controls and free floats with capital controls. Hence, the bipolar view does not strictly hold in the sense that intermediate regimes are significantly more prone to currency crises than the two extreme regimes. However, the fact that hard pegs with capital account liberalization are substantially less prone to currency crises is worthy of note.

The choice of exchange rate regimes is one of the most important topics in international economics that has been studied and debated over recent decades. This topic has gained momentum following the major currency crises in the 1990s (e.g., the European Monetary System (EMS) crisis in 1992–1993, the Mexican crisis in 1994–1995, and the Asian crisis in 1997–1998). In a world with increasingly integrated capital markets, what sort of exchange rate regime is sustainable? Which types of exchange rate regimes are more prone to crises? To answer these questions, some researchers have suggested that in a world of increasing international capital mobility, only the two extreme exchange rate regimes (either hard pegs such as dollarization, currency boards and monetary unions, or a freely floating regime) should be adopted, in order to avoid currency crises and are likely to be sustainable (Eichengreen, 1994, Obstfeld and Rogoff, 1995, Summers, 2000 and Fischer, 2001). Conversely, intermediate exchange rate regimes (such as conventional pegs, basket pegs, crawling pegs, bands, or managed floating) are likely to be vulnerable to speculative attacks and will be unsustainable. This view has come to be known as the bipolar view. According to the bipolar view, monetary authorities need to achieve greater credibility to avoid speculative attacks on their currencies by adopting hard pegs, if they truly want to stabilize their currencies. Hard pegs can enhance credibility in their currencies because they express a commitment to abandon monetary policy autonomy and have higher verification and greater transparency for monetary and exchange rate policies than other regimes. However, since intermediate regimes have a lack of verification and transparency for exchange rate policies, they cannot sufficiently obtain credibility of currencies, thereby causing speculative attacks and currency crises. On the other hand, Williamson (2000) has proposed the usefulness of the intermediate regimes of the BBC (basket, band, crawling) rules because the stabilization of real effective exchange rates is important for the sustainability of exchange systems. He has suggested that intermediate regimes could help prevent misalignments and provide greater flexibility to cope with shocks, while hard pegs and free floats could generate misalignments that could damage their sustainability. According to the BBC rules, intermediate regimes are substantially less prone to currency crises. Are free floats safe from currency crises? Since free floats have the greatest degree of monetary autonomy compared with other regimes, if countries that lack the governance and credibility for monetary regimes adopt free floats, they cannot sufficiently obtain credibility of their currencies, thereby causing speculative attacks and currency crises. Some empirical studies have investigated the links between exchange rate regimes and currency crises by using various datasets and methods. Ghosh et al. (2003), Bubula and Ötker-Robe (2003), Rogoff et al. (2004), Husain et al. (2005), and Haile and Pozo (2006) have all conducted major studies. Ghosh et al. (2003) estimate the occurrence of currency crises under alternative exchange rate regimes (e.g., pegged regimes (include hard pegs, conventional pegs, and basket pegs), intermediate regimes, and floating regimes (include managed floating and freely floating) in IMF member countries from 1972 to 1999 using the data of the International Monetary Fund (IMF) de jure classification, and they find that the probability of crises is the highest for floating regimes.1 Bubula and Ötker-Robe (2003) examine the link between exchange rate regimes and currency crises in IMF member countries from 1990 to 2001 by estimating logit models based on the data of the de factoBubula and Ötker-Robe (2002) classification.2 They find that the probability of currency crises is significantly higher for intermediate regimes than for both hard pegs and floating regimes. Hence, they indicate that the bipolar view of exchange rate regimes holds in the sense that intermediate regimes are significantly more prone to currency crises compared with both hard pegs and floating regimes. Rogoff et al. (2004) and Husain et al. (2005) estimate the probability of currency crises under different types of exchange rate regimes (e.g., peg, limited flexibility, managed floating, and freely floating) from 1970 to 2000 using the data of the de factoReinhart and Rogoff (2004) classification. According to their results, managed floating has the highest probability of currency crises for all countries.3 Haile and Pozo (2006) investigate whether exchange rate regimes affect the incidence of currency crises in 18 developed countries from 1974 to 1998 by estimating probit models based on the data of the IMF classification and the de factoLevy-Yeyati and Sturzenegger (2005) classification.4 They find that while the probability of currency crises is significantly higher for pegged regimes (the group of hard pegs, conventional pegs, and basket pegs) than for other regimes when the IMF classification is used, there is no significant link between exchange rate regimes and currency crises when the Levy-Yeyati and Sturzenegger (2005) classification is used. Judging from the above, however, these previous studies provide a mixed view of the impact of exchange rate regimes on the occurrence of currency crises. Therefore, it is very useful to investigate which types of exchange rate regimes are more susceptible to speculative attacks and currency crises and which exchange rate regimes can avoid currency crises. Accordingly, this paper empirically examines the link between de facto exchange rate regimes and the occurrence of currency crises in 84 countries from 1980 to 2001 using probit models. We employ the de facto classification of Reinhart and Rogoff (2004) as the data of actual exchange rate regimes. Using the data of Reinhart and Rogoff (2004) allows us to estimate the impact of relatively long-lived actual exchange rate regimes on currency crises with much greater precision because Reinhart and Rogoff (2004) treat high-inflation countries as another category, and their data have a relatively longer duration of exchange rate regime compared with other de facto data. First, we empirically investigate whether the bipolar view holds in the sense that intermediate regimes are significantly more prone to currency crises compared with both hard pegs and free floats, as in Bubula and Ötker-Robe (2003). Then, we precisely examine the connection between exchange rate regimes under restricted or liberalized capital flows and currency crises using the combined data of exchange rate regimes and the existence of capital controls. Policymakers in any open economy face the macroeconomic policy trilemma (also known as the impossible trinity) when they choose an exchange rate regime (Obstfeld and Taylor, 2004). The macroeconomic policy trilemma is the hypothesis in international economics that it is impossible to achieve all three of the following objectives simultaneously: (1) a fixed exchange rate, (2) free international capital mobility, and (3) monetary policy autonomy toward domestic goals. Therefore, a crucial insight of the trilemma is that policymakers need to consider the choice of policy stance toward capital flows simultaneously when they choose their exchange rate regime. It is important to explicitly take into account the existence of capital controls. However, no previous research has attempted to examine the link between actual exchange rate regimes and the occurrence of currency crises by explicitly taking into account the existence of capital controls from the viewpoint of the macroeconomic policy trilemma. Accordingly, by applying the macroeconomic policy trilemma, we empirically investigate whether hard pegs under no capital controls that have no monetary policy autonomy significantly increase or decrease the probability of currency crises compared with other regimes. By doing so, we can indirectly investigate the link between the degree of monetary policy autonomy and the incidence of currency crises. Moreover, in this analysis, we empirically verify whether hard pegs with capital account liberalization are really less prone to speculative attacks and currency crises, as the context of the bipolar view suggests. The paper is organized as follows. Section 2 presents the method used to identify currency crises and the data of exchange rate regimes and capital controls. Section 3 presents an empirical probit model of currency crises. Section 4 examines whether intermediate regimes really have a higher risk of currency crises than both hard pegs and free floats by estimating probit models. Section 5 investigates the link between exchange rate regimes under restricted or liberalized capital flows and currency crises using the combined data of exchange rate regimes and the existence of capital controls. Section 6 concludes. Finally, Appendix A details various currency crisis episodes.

In this paper, we have empirically examined the link between de facto exchange rate regimes and the occurrence of currency crises in 84 countries from 1980 to 2001 using probit models. First, we have empirically investigated whether intermediate regimes significantly increase the probability of currency crises compared with hard pegs and free floats, as the bipolar view suggests. We have then investigated the link between exchange rate regimes under restricted or liberalized capital flows and the occurrence of currency crises using the combined data of exchange rate regimes and the existence of capital controls. We have found several interesting results. First, intermediate regimes do not significantly increase the probability of currency crises compared with both hard pegs and free floats. Therefore, we suggest that the bipolar view does not hold in the sense that intermediate regimes are more prone to currency crises compared with the two poles. Second, hard pegs with capital account liberalization significantly decrease the likelihood of currency crises compared with intermediate regimes with capital controls and free floats with capital controls. Third, the probability of currency crises increases with greater monetary policy autonomy. From the viewpoint of the macroeconomic policy trilemma, hard pegs with capital account liberalization abandon monetary policy autonomy and have strict discipline for macroeconomic policy. Therefore, we can reasonably conclude that hard pegs with capital account liberalization are substantially less prone to speculative attacks because they can enhance greater credibility in their currencies by maintaining strict discipline for monetary and macroeconomic policies. Hence, the spirit of the bipolar view is lasting, even though it does not strictly hold.