A Model of Exchange Rate Regime Choice in the Transitional Economies of Central and Eastern Europe, Issues 2001-2140
The paper develops a model of exchange rate regime choice centered on the trade-off between internal price stability and external competitiveness and allowing for institutional costs of altering exchange rate arrangements. The main implication of the model is a nonlinear relationship between the rate of inflation and the choice of regime for the next period. The model also suggests that a major inflationary shock-like the one to which all Central and Eastern European economies were subject when they allowed prices to be determined by the market-should give rise to a tightening of the exchange rate regime, followed by a gradual introduction of more flexibility as inflation subsides. A series of regressions on a sample of 13 Central and Eastern European economies yield results consistent with the hypothesis.
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affect the choice Albania baseline regression Bulgaria Central and Eastern choice of exchange choice of regime coefficient correlated crawling band crawling peg credibility Croatia currency board current account Czech Rep degree of exchange dependent variable devaluation dummies Eastern Europe Equation Estonia Exchange Arrangements exchange rate arrangements exchange rate flexibility exchange rate regime Fixed Effect Estimation fixed effects fixed exchange rate fixed regime flexible regime foreign exchange high inflation countries Hungary IMF classification IMF’s increases inflation rate Inflation Squared international reserves lagged regime Latvia liberalization index Lithuania loss function low inflation Macedonia money-based stabilization nominal anchor Number of Observ number of robustness one-period optimal currency areas Ordered Logit past inflation percent Poland policymakers Prev Previous Regime price liberalization Pseudo R-squared rate flexibility according rate of crawl rate of inflation real appreciation regime and inflation Romania sample Slovenia statistically significant trade trade-off transitional economies unemployment z-statistics in parentheses zero inflation