Will You Buy My Peg? the Credibility of a Fixed Exchange Rate Regime As a Determinant of Bilateral Trade

Abstract

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper examines the relationship between fixed exchange rate arrangements and trade using a gravity model of international trade together with bilateral trade data from 24 countries from the Caribbean and Latin America for the period 1960-2001. The analysis indicates that a credible fixed peg has a positive impact on the value of bilateral trade. Moreover, the positive impact on trade is more pronounced with a stricter definition of the fixed peg or a longer duration of the peg. This supports the argument that the credibility of an exchange rate peg is an important element to determine bilateral trade. There is, however, no evidence to suggest that a currency union provides additional benefits.

Monetary commitment and structural reforms: a dynamic panel analysis for transition economies

“…The theoretical argument and the focus on exchange rate policy as proxy of monetary commitment can be forcefully made for CEEC/CIS transition economies, where EXR commitment has been explicitly used as anchor/commitment technique in the absence of inherited institutional credibility and in the presence of domestic instability in the early phase of transition (see, for instance, Allard, 2009, and as an early source Hobza, 2002, andNational Bank of Hungary, 2002). 1 Since transition economies are frequently exposed to foreign exchange risks, pegging may reduce transaction costs and stimulate domestic economic activity through an increase in trade or capital inflows (Jurtyk and Fritz-Krockow, 2004). From a theoretical point of view, disinflation through pegging the exchange rate is equivalent to disinflation through reducing monetary growth in case of an initial currency revaluation.…”