Currency Crises and Regime Changes

Abstract

After the collapse of the Bretton Woods system of fixed exchange rates in the early 1970s, most currencies broadly transitioned towards more liberal arrangements. However, as of 2019 only a small minority of countries freely float, with a significant majority following fixed or intermediate currency regimes. This thesis explores the costs of maintaining an exchange rate peg in terms of macroeconomic instability associated with adhering to a peg, the stock of reserves needed to defend the value of a currency, and the trade-offs involved in transitioning between different currency regimes. Broadly these chapters demonstrate that fixed regimes are not a panacea for monetary authorities in search of stability, rather they are extremely costly. Excessive stocks of reserves are needed to successfully defend a peg, with intervention double the mean only improving the likelihood of success by 1.5 percentage points. Further, transitions between fixed and floating regimes can alter the propagation of shocks both during and after the regime change. Ultimately, the benefit of exchange rate stabilisation may come at the cost of short-term instability in inflation, output, and other domestic outcomes.