Exchange Arrangements Entering the 21st Century: Which Anchor Will Hold?

Abstract

This paper provides a comprehensive history of anchor or reference currencies, exchange rate arrangements, and a new measure of foreign exchange restrictions for 194 countries and territories over 1946-2016. We find that the often-cited post-Bretton Woods transition from fixed to flexible arrangements is overstated; regimes with limited flexibility remain in the majority. Our central finding is that the US dollar scores (by a wide margin) as the world's dominant anchor currency and, by some metrics, its use is far wider today than 70 years ago. In contrast, the global role of the euro appears to have stalled in recent years. While the incidence of capital account restrictions has been trending lower for decades, an important wave toward capital market integration dates as recently as the mid-1990s. We suggest that record accumulation of reserves post 2002 has much to do with many countries' desire to stabilize exchange rates in an environment of markedly greater capital mobility. Indeed, the continuing desire to manage exchange rates despite increased capital mobility post-2003 may be a key factor underpinning the modern-day Triffin dilemma that some have recently pointed to.

The great moderation in international capital flows: A global phenomenon?

“…Moreover, the share of FDI in international capital flows has increased as FDI has proven to be relatively robust. 32 Finally, we find a significant role for monetary policy as a driver of financial flows since the crisis, in particular on the asset side. Thus, it remains to be seen if the great moderation in the volatility of international capital flows will be robust to an unwinding or divergence of monetary policies across advanced economies.…”

Pegging the Exchange Rate to Gain Monetary Policy Credibility

“…The dependent variable in this empirical exercise is an index of whether a country has a fixed or floating exchange rate is from Ilzetzki, Reinhart, and Rogoff (2008). This index varies from (1) -"no separate legal tender" to (13) As a proxy for central bank credibility we use the index of central bank independence from Dincer and Eichengreen (2013).…”

“…* denotes significance at the 10% level, ** denotes significance at the 5% level, *** denotes significance at the 1% level Ilzetzki, Reinhart, and Rogoff (2008) 1 No separate legal tender 2 Pre announced peg or currency board arrangement 3 Pre announced horizontal band that is narrower than or equal to +/-2% 4 De facto peg 5 Pre announced crawling peg 6 Pre announced crawling band that is narrower than or equal to +/-2% 7 De facto crawling peg 8 De facto crawling band that is narrower than or equal to +/-2% 9 Pre announced crawling band that is wider than or equal to +/-2% 10 De facto crawling band that is narrower than or equal to +/-5% 11 Moving band that is narrower than or equal to +/-2% (i.e., allows for both appreciation and Bottom half -Welfare loss from optimal policy as a function of the commitment probability γ. Blue: No modifications to central bank objective function, red: optimal extra weight on inflation, green: optimal weight on the nominal exchange rate.…”

U.S. Monetary Policy Normalization and Global Interest Rates

“…More precisely, we first estimate the model with only two fundamentals in , capturing the exchange rate regime and the degree of financial openness-the two pillars of the traditional monetary trilemma. The exchange rate regime corresponds to the coarse classification in Reinhart and Rogoff (2004) that has been updated by Ilzetzki, Reinhart, and Rogoff (2009). The financial openness index is from Chinn and Ito (2006) and Aizenman, Chinn, and Ito (2010).…”