Exchange Rate Policy Tensions: A Comparative Study between North Africa and Central &Eastern Europe Ali Massoud, Sohag University, Egypt Julius Horvath, CEU, Hungary First World Congress of Comparative Economics June 2015, Rome

How to Choose an Exchange Rate Regime 1. Take a macroeconomic model and evaluate which exchange rate regime could ease the response of the economy to different disturbances; Poole (1970), Fischer (1977); typically: if exposed to external nominal shocks should use float; when exposed to domestic nominal shocks use a fixed regime 2. Exchange rate regime in the context of stabilization plans; see for example Dornbusch (1986), Bruno (1991) 3. Credibility versus flexibility trade-off, time inconsistency literature; Fratianni and von Hagen (1992): peg helps in importing credibility for domestic economy 2

How to Choose an Exchange Rate Regime 4. Optimum Currency Area: take into consideration country’s economy structural characteristics (labor mobility, diversification, openness and others) 5. Consider ex post macroeconomic performance under different exchange rate regimes and explore what was the effect of these different exchange rate regimes on basic macro variables and consequently adjust the exchange rate regime These 5 approaches assumed that when choosing exchange rate countries have all possible options available (from giving up its currency in a monetary union till pure float) After currency crisis (EMS, Mexico, Asian etc) new concepts evolved arguing that options given to countries are limited: 3

View No 1: Vanishing Intermediate Exchange Rate Regimes In times of widespread speculative attacks; an idea that to prevent speculative attacks countries opt for the corner solutions as ‘soft pegs’ not sufficient to protect the currency Kenen (1988) Eichengreen (1994) to prevent currency crisis either increase flexibility or true rigidity is needed Hypothesis of the vanishing intermediate exchange rate regime, ‘corner solutions’: i.e. abandon basket pegs, crawling pegs, adjustable pegs and different combinations of these Frankel, Fajnzylber, Schmukler and Serven (2001) a simple regime (rigid or flexible) is more verifiable by market participants than a complicated intermediate exchange rate regime 4

View No 2 Countries Do Not Opt for Corner Solutions The ‘fear of floating’, Calvo and Reinhart (2002), reluctance of monetary authorities to allow completely free fluctuations of their currencies to avoid depreciation hurting domestic financial system There is nothing to prevent a country from pursuing an intermediate regime in which half of every fluctuation in demand for its currency is accommodated by intervention and half is allowed to be reflected in the exchange rate; Frankel (1999) Edwards (2000): “From a historical perspective the current support for the two-corner approach is largely based on the shortcomings of the soft pegs …, and not the historical merits of the two corner systems. “ 5

Specificities of Emerging Markets Calvo and Mishkin (2003) emerging markets decision about exchange rate regime more difficult than in developed countries; they are more vulnerable: fiscal, financial, monetary institution; currency substitution, liability dollarization, increased vulnerability to sudden stops of capital inflows An argument called impossible trinity: fixed exchange rate, independent monetary policy and freedom of capital movements do not go together; Cooper (1999) this holds only for large and diversified economies with well developed financial markets Cooper (1999): floating rates, independent monetary policy, and freedom of capital movements may be incompatible for countries with poorly developed domestic capital markets as in these price levels are strongly influenced by exchange rates 6

7 De facto (actually prevailing) and de jure (officially reported) exchange rate regimes In exchange rate policy making - at times - behavior of the government might not follow government’s own initial intention This creates the basis for the de facto exchange rate regime being different from de jure exchange rate regime

How to Distinguish Empirically the De Facto Regime from De Iure Regime Attempts to classify countries according to de facto exchange rate regime, as Bubula and Ötker-Robe (2002), Reinhart and Rogoff (2004) and Levy-Yeyati and Sturzenegger (2005) Exchange market pressure on a currency is its excess supply in the foreign exchange market If there is a float this excess supply is expressed in the relative depreciation, which then removes the exchange market pressure 8

How to Distinguish Empirically the De Facto Regime from De Iure Regime In any other regime, not pure float, the monetary authorities prevent depreciation by policy measures, such as setting a higher interest rate, or buying domestic currency in the foreign exchange market Then the actual depreciation does not coincide with exchange market pressure Exchange market pressure is unobservable (except for a pure float) needs to be estimated and so I leave floor to the co-author to present the methodology and results of the estimation 9

The Frankel and Wei’s methodology Δ log DC(i) t = C + ∑ w(j) Δ log X(j) t + δ { Δ emp(i) t } + µ t (1) Δ emp(i) t = Δ log DC(i) t + Δ Res(i) t /MB(i) t (2) Δ log DC(i) t = C + w 1 Δ log USD t + w 2 Δ log EURO t + w 3 Δ log BP t + δ { Δ emp(i) t } + µ t (3) [ΔlogDC(i) t - ΔlogBP t ]= C+w1 [ΔlogUSD t - Δlog BP t ] + w 2 [Δlog EURO t - Δlog BP t ] + δ {Δemp(i) t } + µ t (4) 10

Table (1): Estimation of the Flexibility Index of the Algerian Dinar VariableRegression (1)Regression (2)Regression (3)Regression (4) USD 0.354*** (0.001) 0.426*** (0.000) 0.524*** (0.000) 0.526*** (0.000) EURO 0.283*** (0.001) 0.334*** (0.000) 0.417*** (0.000) 0.415*** (0.000) British Pound0.038*** (0.000)0.047 (0.203)-- EMP 0.762*** (0.000) 0.709*** (0.000) 0.746*** (0.000) 0.698*** (0.000) C (0.796) (0.689) (0.789) (0.673) Observations Adj.R DW Sample2002M1:2014M102004M1:2014M102002M1:2014M102004M1:2014M10 11

Table (2): Estimation of the Flexibility Index for Egypt 12 Variable / Regression(1)(2)(3)(4) USD 0.002** (0.034) (0.962) 0.075*** (0.000) 0.091*** (0.000) EURO (0.523) (0.351) 0.089*** (0.000) 0.009*** (0.000) BP (0.657) (0.831) -- EMP 0.871*** (0.000) 0.975*** (0.000) 0.911*** (0.000) 0.987*** (0.000) C (0.468) (0.001) (0.778) (0.719) Observations Adj.R DW Sample2003M1:2012M112005M1:2010M122003M1:2012M112005M1:2010M12

Table (3): Estimation of the Flexibility Index for Tunisia 13 Variable / Regression(1)(2)(3)(4) USD (0.804) (0.962) 0.395*** (0.000) 0.379*** (0.000) EURO (0.250) (0.351) 0.421*** (0.000) 0.450*** (0.000) BP 0.119** (0.012) 0.134* (0.008) -- EMP (0.260) (0.867) (0.424) (0.819) C *** (0.001) *** (0.001) 0.001*** (0.000) *** (0.002) Observations Adj.R DW Sample1999M2:2014M92005M1:2014M91999M2:2014M92005M1:2014M9

Table (4): Estimation of the Flexibility Index for Croatia 14 Variable / Regression (1)(2)(3)(4) USD (0.501) (0.615) (0.684) (0.253) EURO 1.002*** (0.000) 0.957*** (0.026) 0.956*** (0.000) 0.880*** (0.000) BP (0.196) (0.869) -- EMP 0.079*** (0.000) (0.191) (0.424) (0.158) C (0.877) (0.377) (0.000) (0.366) Observations Adj.R DW Sample2002M1:2013M62013M7:2014M102002M1:2013M62013M7:2014M10

Table (5): Estimation of the Flexibility Index for the Czech Republic 15 Variable / Regression(1)(2)(3)(4) USD (0.664) (0.139) 0.185* (0.055) 0.126** (0.004) EURO (0.279) 0.480*** (0.000) 0.703*** (0.000) 0.782*** (0.000) BP (0.971) (0.197) -- EMP 0.709*** (0.000) 0.653*** (0.000) 0.712*** (0.000) 0.630*** (0.000) C (0.911) (0.810) (0.863) (0.775) Observations Adj.R DW Sample2002M2:2004M42004M5:2014M92002M2:2004M42004M5:2014M9

Table (6): Estimation of the Flexibility Index for Hungary 16

Table (7): Estimation of the Flexibility Index for Poland 17 Variable / Regression(1)(2)(3)(4) USD (0.764) *** (0.000) EURO *** (0.000) *** (0.000) BP *** (0.006) -- EMP (0.916) (0.937) C (0.537) (0.537) Observations-126- Adj.R DW Sample-2004M5:2014M10-

Table (8): Estimation of the Flexibility Index for Romania 18 Variable / Regression(1)(2)(3)(4) USD (0.417) 1.210*** (0.000) 0.187** (0.096) ** (0.054) EURO (0.189) 1.975*** (0.000) 0.447** (0.016) 0.892*** (0.000) BP 0.459* (0.099) 0.353*** (0.000) -- EMP.002 (0.852) (0.546).002 (0.820) (0.447) C (0.460) (0.196) (0.517) (0.184) Observations Adj.R DW Sample2002M1:2006M122007M1:2014M102002M1:2006M122007M1:2014M10

Table (9):The IMF De Facto Classification of Exchange Rate Regimes in some of the Northern African Countries 19 Year/CountryAlgeriaEgyptTunisia 2014 (April 30) Other Managed Arrangement (Composite) De Jure Stabilized Arrangement (Other) De Jure Crawl-Like Arrangement (Other) De Jure 2013Other Managed Arrangement Composite) Crawl-Like Arrangement (Other) Crawl-Like Arrangement (Other) 2012 (April 30) Other Managed Arrangement (Composite) Stabilized Arrangement (Other) Crawl-Like Arrangement (Other) 2011Other Managed ArrangementCrawl-Like Arrangement (Other) Stabilized Arrangement (Composite) 2010Other Managed Arrangement (Other) Stabilized Arrangement (MT)

Table (10):The IMF De Facto Classification of Exchange Rate Regimes in some Central and Eastern European Countries. 20 Year/CountryCroatiaCzechHungaryPolandRomania 2014 (April 30) Crawl-Like Arrangement (Euro) De Jure Other Managed Arrangement (IT) De Jure Floating (IT) De Jure Free Floating (IT) De Jure Floating (IT) De Jure 2013Crawl-Like Arrangement (Euro) Free Floating (IT) Floating (IT) Free Floating (IT) Floating (IT) 2012 (April 30) Crawl-Like Arrangement (Euro) Free Floating (IT) Floating (IT) Free Floating (IT) Floating (IT) 2011Crawl-Like Arrangement (Euro) Free Floating (IT) Floating (IT) Free Floating (IT) Floating (IT) 2010Stabilized Arrangement (Euro) Free Floating (IT) Floating (IT) Free Floating (IT) Floating (IT)