## A Field Guide to Exchange Rate Regimes in Central, Eastern and Southeastern Europe

_IMF Blog, November 29, 2016_

## Source details

**Canonical URL:** [A Field Guide to Exchange Rate Regimes in Central, Eastern and Southeastern Europe](https://www.imf.org/en/blogs/articles/2016/11/29/a-field-guide-to-exchange-rate-regimes-in-central-eastern-and-southeastern-europe)

## Other formats

- [Markdown version](/en/blogs/articles/2016/11/29/a-field-guide-to-exchange-rate-regimes-in-central-eastern-and-southeastern-europe/index.md)
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## Bibliographic details
- Authors: Philip Gerson, Johannes Wiegand
- Published: November 29, 2016

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### Overview
- Authors: Philip Gerson, Johannes Wiegand
- Date: November 29, 2016
- Region examined: Central, Eastern and Southeastern Europe (CESEE)
- Context: CESEE experienced a capital-flow-fueled boom in the early and mid-2000s, a sharp recession after the 2008 global financial crisis, and a gradual recovery over the past 15 years or so. The region exhibits almost every type of exchange rate regime: floating and inflation targeting, various pegs, unilateral use of the euro, and full euro area membership.

### Key findings
- Flexible versus fixed regimes and boom-bust dynamics:
  - Economies with flexible exchange rates experienced a more muted pre-2008 boom, a shorter and shallower recession, and a more robust recovery compared with economies with fixed exchange rates.
  - Flexible exchange rates tended to mitigate the impact of capital in- and outflows, while fixed exchange rates magnified them (see Chart 1).
  - Fixed exchange rates can amplify capital flows through pro-cyclical credit booms, a pattern clearly visible in CESEE.

- Long-term effects on potential growth:
  - Excessive boom and bust continues to affect economies long after episodes end.
  - Potential growth in economies with fixed exchange rates is now, on average, almost a percentage point below that of economies with flexible exchange rates, as high private sector debt accumulated during the boom weighs on investment (see Chart 2).

- Historical drivers of regime choice:
  - Fixed exchange rates in CESEE are often rooted in experiences with hyperinflation during the 1990s (see Chart 3).
  - Where populations suffered hyperinflation, distrust of local currencies persists; depositors are much more likely to hold bank deposits in euros.
  - In such environments, tying the currency to a strong anchor like the euro can provide stability and instill confidence, which can be more important than better management of credit cycles.

### Policy options and recommendations
- For countries with flexible exchange rates:
  - Little need for reorientation; flexible regimes have generally served them well.
  - Continued emphasis on good economic management across monetary, fiscal and structural policies remains critical.

- For countries with fixed exchange rate regimes: two broad strategies
  - Strategy 1 — Gradually increase exchange rate flexibility:
    - Preconditions and measures: strong macroeconomic policies; regulatory measures that encourage the use of the domestic currency; an extended period of low inflation, solid growth and exchange rate appreciation to solidify confidence in the domestic currency.
    - Feasibility: depends on country circumstances; some CESEE countries may now have sufficiently strong institutions to transition, others may need the fixed exchange rate as a stability anchor for some time.
    - Considerations for euro adoption: for countries expecting to adopt the euro soon, the upfront costs of transitioning to more flexibility may not be worthwhile.
    - Role for European institutions:
      - Greater acceptance of prudential measures that promote the use of local currencies, rather than interpreting these as quasi-capital controls inconsistent with European treaties.
      - A financial safety net during the transition to flexibility—for example in the form of unsecured European Central Bank swap lines—could help overcome populations’ entrenched distrust in floating currencies.

  - Strategy 2 — Make existing fixed regimes work better:
    - Required elements: high wage flexibility; much stronger use of countercyclical fiscal and macro-prudential policies.
    - Implementation challenges:
      - Running countercyclical fiscal policy is challenging for emerging economies because of low fiscal multipliers, financing constraints, and political economy pressures.
      - Macro-prudential policies that restrict bank lending suffer from evasion, with banks circumventing regulations in one country by providing loans cross-border from another.
      - Therefore, effective macro-prudential measures require a coordinated European anti-evasion effort.

### Synthesis and outlook
- No single exchange rate regime is inherently superior; suitability depends on local conditions and historical legacies.
- Regimes need to evolve as conditions change; failure to adapt risks economies falling behind.
- The trade-off for CESEE policymakers is balancing stability (often provided by fixed regimes anchored to the euro) against greater shock absorption and potentially less pronounced boom-bust cycles under more flexible regimes.

*Source: A Field Guide to Exchange Rate Regimes in Central, Eastern and Southeastern Europe — Philip Gerson, Johannes Wiegand, November 29, 2016*

---

## Content in this bundle

- **BROWN—The Euroization of Bank Deposits in Eastern Europe**
  - [BROWN—The Euroization of Bank Deposits in Eastern Europe (Markdown version)](/wp-content/uploads/2014/06/BROWN-The-Euroization-of-Bank-Deposits-in-Eastern-Europe.pdf.md){rel="alternate" type="text/markdown"}
  - [BROWN—The Euroization of Bank Deposits in Eastern Europe (PDF)](/wp-content/uploads/2014/06/BROWN-The-Euroization-of-Bank-Deposits-in-Eastern-Europe.pdf){rel="external" type="application/pdf"}
- **Wp1241**
  - [Wp1241 (Markdown version)](/external/pubs/ft/wp/2012/wp1241.pdf.md){rel="alternate" type="text/markdown"}
  - [Wp1241 (PDF)](/external/pubs/ft/wp/2012/wp1241.pdf){rel="external" type="application/pdf"}
- **Wp1629**
  - [Wp1629 (Markdown version)](/external/pubs/ft/wp/2016/wp1629.pdf.md){rel="alternate" type="text/markdown"}
  - [Wp1629 (PDF)](/external/pubs/ft/wp/2016/wp1629.pdf){rel="external" type="application/pdf"}

---

## References

- [new paper](http://www.imf.org/external/pubs/cat/longres.aspx?sk=44425.0)
- [https://www.imf.org/wp-content/uploads/2016/11/eur-excratesreg-chart1.jpg](https://www.imf.org/wp-content/uploads/2016/11/eur-excratesreg-chart1.jpg)
- [https://www.imf.org/wp-content/uploads/2016/11/eur-excratesreg-chart2.jpg](https://www.imf.org/wp-content/uploads/2016/11/eur-excratesreg-chart2.jpg)
- [https://www.imf.org/wp-content/uploads/2016/11/eur-excratesreg-chart3.jpg](https://www.imf.org/wp-content/uploads/2016/11/eur-excratesreg-chart3.jpg)

_Source: https://www.imf.org/en/blogs/articles/2016/11/29/a-field-guide-to-exchange-rate-regimes-in-central-eastern-and-southeastern-europe_