نقش توسعه مالی در انتخاب رژیم نرخ ارز

We make the first attempt in the literature to empirically investigate the role of financial development in the choice of exchange rate regimes. Using a binary choice model, we first show that financially less developed countries are more likely to adopt a fixed exchange rate. To further examine the impact of financial development on the conditional probability of exiting from an existing pegged system to a flexible one, we then employ hazard-based duration analysis. We find strong evidence that countries with higher levels of financial development are more likely to exit a pegged system, and, interestingly, financial development only matters to orderly exits but not disorderly exits. Our results are robust to controlling for endogeneity and sample selection.

Foreign exchange rate policies — whether to adopt a fixed or flexible exchange rate regime — have long been at the heart of policy debates among academic researchers and policymakers.1 As the traditional Mundell–Fleming model (Fleming, 1962 and Mundell, 1963) suggests, a country’s exchange rate regime choice should be based on the sources of shocks, the level of capital mobility and the preference for independent monetary policies.2 According to the optimal currency area theory proposed by Mundell (1961), a country’s exchange rate regime decision should also take into account its trade openness, country size and trading relationship with its pegging country, etc. Furthermore, the view (Bruno, 1990, Calvo and Végh, 1994 and Mecagni, 1995) that pegging to a sound currency can provide an inflation anchor implies that a country should consider a fixed exchange rate when it intends to keep domestic inflation under control but lacks policy credibility. While the above conventional theories of exchange rate regime determination have been quite successful in explaining many countries’ exchange rate regime choices in practice, there are certainly some exceptions. Consider the case of China. Although, based on the conventional theories, many researchers suggest that a flexible exchange rate regime would fit China better, the country has been very reluctant to exit from its de facto fixed exchange rate regime to a more flexible one. More generally, an influential study by Calvo and Reinhart (2002) find that there is an epidemic case of “fear of floating” among emerging and developing countries. Why are those countries so afraid of allowing their exchange rates to fluctuate? Two recent studies, Bordo (2003) and Bordo and Flandreau (2003), propose a novel rationale for the above puzzling real world exchange rate arrangements by exploring the role of financial development in exchange rate regime choices. Their idea is later formalized by Aghion et al. (2009) (ABRR thereafter).3 In ABRR’s study, the authors first employ a monetary growth model to show that exchange rate volatility amplifies the negative investment effects of domestic credit market constraints. In their model, exchange rate volatility leads to large variations in firms’ profits. With underdeveloped financial markets, the large profit volatility would greatly reduce firms’ external financing capability, depress their investment, especially in R&D, and eventually curtail a country’s productivity growth. They then provide some convincing empirical evidence that higher levels of flexibility in exchange rate are associated with lower productivity growth when financial development is limited. Taken together, they thus conclude that financial development plays a critical role in countries’ choices of exchange rate regimes and that less flexible exchange rate regimes should be considered in countries with less developed financial markets. Despite this theoretical prediction on the role of financial development in exchange rate regime choices, direct and formal empirical tests have yet to be done on this interesting and important issue. Does financial development really matter to a country’s exchange rate regime choice in the real world? Is a country with lower financial development more likely to adopt a fixed exchange rate regime in reality? Does financial development play a role in a country’s transition from a fixed exchange rate regime to a flexible one? Our study makes the first attempt in the literature to address the above important questions by empirically investigating the role of financial development in the selection of exchange rate systems. We first use a conventional simple logit model to examine the effect of financial development on the unconditional probability of adopting fixed exchange rate regimes. A limitation of this approach, however, is that it considers the selection of exchange rate regimes as independent events without taking into account the existing exchange rate arrangement prior to the current choice. We then take another step forward to further examine how financial development affects the probability of switching from a fixed exchange rate regime to a flexible one, conditional on the length of time a country has been in a fixed exchange rate regime, by employing a hazard-based duration analysis. This novel approach not only allows us to explore the conditional likelihood of exiting from a fixed to a flexible exchange rate system but also sheds some light on the role of financial development in the durations of fixed exchange rate regimes.4 In addition, we also make efforts to distinguish orderly exits from disorderly ones in our duration analysis by incorporating a competing risks framework.5 In doing so, we are able to check whether financial development facilitates smooth exits from a fixed exchange rate regime or actually causes economic turmoil. Based on a comprehensive sample of 102 economies over the post-Bretton-Woods era, our logit regressions show that financial development does have a significant influence on a country’s choice of exchange rate regime. The less developed a country’s financial market is, the more likely the country will adopt a fixed exchange rate regime. Our duration analyses further reveal that a country is more likely to exit from a fixed exchange rate regime to a flexible one when its financial market is more developed. For example, had China’s financial development in 2005 reached the concurrent level of that of the US, the hazard rate (i.e. the risk of exiting from a fixed exchange rate) that China faced would have increased by a factor of 3.06 (306%)! Interestingly, we notice that financial development only affects the conditional likelihood of orderly exits but not disorderly exits, suggesting that financial development would only facilitate smooth exits. We also show that our results are robust to controlling for endogeneity and sample selection. Overall, the evidence lends strong support to ABRR’s theoretical prediction that exchange rate flexibility should be positively associated with the level of financial development. The remainder of this paper is organized as follows. A brief introduction of our dataset is provided in Section 2. Section 3 discusses the methodological issues involved in our study. Our main empirical results are presented in Section 4. In Section 5, we address the potential endogeneity and sample selection issues. Section 6 offers our concluding remarks.

This paper empirically examines the impact of financial development on a country’s foreign exchange rate policy. As a first step, we employ logit models to study the influence of financial development on the unconditional probability of choosing fixed exchange rate regimes. We find strong evidence that a country’s financial development is significantly and negatively associated with its choice of a fixed exchange rate regime. When the level of financial development is lower in a country, it is more likely to adopt a pegged exchange rate system. In the second-stage, we further explore the impact of financial development on the conditional probability of exiting from a fixed exchange rate regime by using hazard models. Our studies show that financial development indeed has statistically significant impact on the probability of exiting from a pegged system to a flexible one, conditional on the length of time a country has been in a pegged regime. In particular, the lower the level of financial development, the more likely a country will stay in its fixed exchange rate regime. Furthermore, using a competing risks model, our investigation finds that financial development has different effects on the risk of orderly exits from that of exiting disorderly exits. While higher financial development significantly raises the hazard of orderly exits, it does not have any significant impact on the hazard of disorderly exits at all. We also show that our results hold strongly even after controlling for endogeneity and sample selection. All in all, we have presented strong and supportive evidence for ABRR’s hypothesis that financial development plays a vitally important role in a country’s choice of exchange rate regime and that a country with lower financial development should choose a fixed exchange rate regime. Our empirical evidence also yields two important policy implications for the selection of exchange rate regimes. One is that a country should take into consideration of its own financial development when making a decision about its exchange rate regime. The other is that countries can consider exiting from fixed exchange rate regimes when their financial markets are more developed. Finally, our findings are also of interest to the history of exchange rate regimes literature. Two influential studies, Bordo (2003) and Bordo and Flandreau (2003) find that core advanced countries tended to adopt fixed exchange rate regimes during the Pre-WWI classical gold standard period but floating exchange rate regimes a century later. Also, in both eras, peripheral developing countries attempted to emulate the core countries. What caused the change? In their studies, the authors suggest that financial development is the driving force of the evolution of the international monetary system. In both eras, the exchange rate regimes adopted by the core countries require financial maturity. Moreover, developing countries today can successfully adopt a floating exchange rate regime only if they have reached a sufficiently high level of financial development. Therefore, given their findings, it would be interesting to put our results into historical perspective to study the linkage between exchange rate regimes and financial development under different historical backgrounds and economic environments, and to examine the role of financial development in the evolution of the international monetary system. While a thorough investigation is beyond the scope of this study, it certainly remains a fruitful area for future research.