Does the Nominal Exchange Rate Regime Matter?

Does the Nominal Exchange Rate Regime Matter?
by Atish R. Ghosh, Anne-Marie Gulde, Jonathan D. Ostry, and Holger C. Wolf

Does the choice of the nominal exchange rate regime systematically
influence the behavior of key macroeconomic variables, nominal or real?
Economic theory has yet to yield unambiguous conclusions: increased nominal
exchange rate flexibility has been argued both to aggravate and to reduce
output variability, to enhance and to suppress trade, to raise and to lower
investment, and to raise and to lower inflation. Revealed preference,
moreover, does not suggest a clear ranking among exchange rate regimes.
Eighty-six of the 136 countries sampled in this paper pursued some form of
exchange rate peg, while the remaining 50 allowed their currencies to float.

Deriving clear rankings is made difficult by the plethora of partly
offsetting and partly reinforcing linkages between the exchange rate regime
and a number of macroeconomic variables. Without evidence on which of these
channels matters empirically, few general conclusions are possible. This
paper presents stylized facts on the link between the exchange rate regime
and two key macroeconomic variables--inflation and growth.

A general, positive association is found between the degree of nominal
exchange rate regime flexibility and inflation, a link deriving both from
lower money supply growth (a discipline effect) and higher money demand
growth (a credibility effect) under fixed rates. In contrast, overall
growth performance is not found to differ across exchange rate regimes,
though growth tends to be more variable under fixed exchange rate regimes.
The sources of growth, however, do vary significantly across regimes.
Countries operating under fixed rates invest more and are more open, while
countries under flexible rates enjoy faster residual productivity growth.