Sustaining Fixed Exchange Rates: A Model with Debt and Institutions
IMF Working Papers, March 1, 2001
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- Sustaining Fixed Exchange Rates: A Model with Debt and Institutions
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Bibliographic details
- Authors: Alexander Pitt
- Published: March 1, 2001
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451844528.001
Summary
- Fixed exchange rate regimes have come into disrepute, as their defense has become all but impossible.
- While a determined attack on a currency cannot be prevented or, ultimately, withstood, policies can reduce the vulnerability of a country to such attacks.
- The paper develops an analytical framework of costs and benefits of a fixed exchange rate, based on the ability of a developing country to meet its external obligations while achieving a maximum rate of long-term output growth.
- The focus is on how structural policies and institutions influence the degree of dependence of a country on a fixed exchange rate regime.
Major themes and analytical focus
- Costs and benefits of maintaining a fixed exchange rate.
- Interaction of debt dynamics with exchange rate regime sustainability (debt accumulation, debt service, debt structure, debt-service cost).
- Role of structural policies and institutions (competition policy, financial supervision, economic system) in reducing dependence on a fixed exchange rate.
- Influence of external factors and rates (world interest rate, risk premium) on exchange rate vulnerability.
- Linkages to financial sector features, foreign direct investment, capital account openness, and exchange rate volatility.
Key findings and concepts highlighted
- Abandonment cost and costs of abandoning a fixed exchange rate are central determinants of regime sustainability.
- Currency attacks can be mitigated in vulnerability by policy choices even if ultimately unstoppable when determined.
- Productivity and return on investment considerations matter for long-term growth under a fixed exchange rate.
- Interest rate cost and risk premium affect the attractiveness and feasibility of defending a fixed exchange rate.
- Exchange rate target and exchange rate volatility vis-à-vis currency are important for balance of payments and national accounts outcomes.
Policy implications and recommendations (as emphasized by the paper)
- Strengthen structural policies and institutions to reduce dependence on a fixed exchange rate regime.
- Improve financial supervision and the financial sector to lower vulnerability to external shocks.
- Adopt policies that manage debt accumulation and debt-service costs to enhance the ability to meet external obligations.
- Encourage conditions that support foreign direct investment and higher productivity to sustain long-term growth without excessive reliance on a fixed exchange rate.
Content in this bundle
- Sustaining Fixed Exchange Rates: A Model with Debt and Institutions - WP/01/27