Alternatives for Exchange Rate Regimes in Advanced Transition Economies
Project

 

Exchange rate policies play a crucial role in transition economies as they influence the outcome and costs of stabilization programs, the speed of structural changes including the shift in the allocation of factors of production between tradable and non-tradable sectors, the speed and sustainability of capital account opening and the outcome of the financial sector reform.

The major exchange rate policy issues have also changed rapidly and currently include the contribution of exchange rate regimes to the management of capital flows and adjustment to the rapid opening of the capital account, the degree and timing of the support given by exchange rate policies to disinflation and the reduction of nominal rigidities and inflation persistence, the adjustment to very different developments in the current and capital accounts of the balance of payments. Equally important is the definition of the path of the equilibrium real exchange rate in a transition economy and the factors that determine its evolution over time. Besides that exchange rate policies have been increasingly influenced by the current and likely future developments related to the European Monetary Union and therefore exchange rate policies have to consider these exogenous developments as well.

Reflecting these priorities of exchange rate policies in advanced transition economies, the research program analysed the factors determining the choice of exchange rate regime under the recent institutional and structural circumstances (completed financial sector liberalization, open capital accounts, significant overall and tradable productivity growth), shifts in the macroeconomic environment from high to moderate but persistent inflation, generally improved fiscal stance but rapidly worsening current account balances and increased volatility of capital flows. The research program focused at evaluating the trade-off between the different exchange rate regimes in the economies in transition, at the issues raised by these institutional and structural shifts in the advanced transition economies.

An important element of the choice of the exchange regime is related to the analysis of the recent shifts to increased exchange rate flexibility reflected in the growing use of wider exchange rate bands, crawling band and managed floating regimes. The program discussed the experiences of transition economies in adopting exchange rate regimes simultaneously supplying higher flexibility and credibility especially in relation to their impact on balance of payments developments, on the competitiveness of tradable sector, on the disinflation efforts of central banks. Besides that the research program evaluated how affected the increased flexibility the effectiveness of monetary policy, and how did it contribute to the changes in the adopted monetary regimes including the increased emphasis on monetary and inflation targeting compared with earlier reliance on exchange rate targeting in the advanced transition economies. With this the program tried to contribute to the ongoing discussion on the costs and benefits of alternative exchange rate regimes and to work out feasible options for policy-makers in advanced transition economies on the use of different exchange rate regimes.

The research program evaluated the role of exchange rate policies in the management of capital flows reducing the risks and costs stemming from unexpected surges and later outflows. The capital inflows have been increasingly determining the macroeconomic developments and their long-term increase is foreseen notwithstanding the recent episodes of capital outflows and increased volatility of capital flows. The research program evaluated the changes in nominal and real exchange rates under the periods of capital in- and outflows, the impact of exchange rate policies on the management of these flows.

Besides analyzing the relationship between the choice of exchange rate regime and the changes in the balance of payments it was equally important to analyze its possible contribution to disinflation. Exchange rate policies were almost exclusively used as a disinflation tool in the first stage of transition and the widespread use of pegged exchange rate regimes shows that this has been changing only gradually. But inflation has generally been reduced from high levels and upper moderate levels to low and lower moderate ones which requires new approach from the exchange rate policy besides serving as a nominal anchor. The research discussed the ways exchange rate policies may influence the speed and costs of disinflation in transition economies.

A related issue was the analysis of the relationship between the choice of the exchange rate regime and of monetary arrangement prevailing in advanced transition economies. These economies have so far followed either exchange rate or money supply targeting, while there have been several cases when these arrangements were modified in the individual economies. Recently there has been increasing problems with these two “traditional” monetary arrangements and there is an increasing shift towards inflation targeting and other arrangements (like nominal income targeting). The program discussed the exchange rate policy implications of this shift and the ways they influence the choice and operation of exchange rate regimes in economies in transition.

A further question was the evaluation of real exchange rate movements in the transition economies since most of them have experienced continuous and significant real exchange rate appreciation. It was important to determine whether this has been an equilibrium movement explained by increased productivity, structural adjustment (including the presence of the Harrod-Balassa-Samuelson-effect) or it is more a reflection of wrong macroeconomic policies. This is of short-term policy issue for most of transition economies as their current macroeconomic trends (including the capital inflows, the current account deficits, the high real interest rate levels, price differentials) predict further real appreciation of their currencies.

Finally, the program focused its attention at evaluating the costs and benefits and feasibility of different exchange rate regimes which are available for the advanced transition economies before entering the E(MU). The program assessed the viability of the available options including currency board arrangements, euroisation, ERM-II plus disinflation ones. Besides the choice of appropriate exchange rate regime, the program also assessed the issues of real and nominal convergence, their impact on nominal and real appreciation.