Celine Gimet

English

Research Papers in Economics

 
PANOECONOMICUS, 2010, 2, pp. 245-249 
Received: 12 April 2010. 
Book review
 
 
 
Celine Gimet 
 
Group for Economic Analysis and 
Theory (GATE),  
University of Lyon, 
France 
 
 gimet@gate.cnrs.fr 
Exchange Rate Regimes in 
Emerging and Transition 
Economies  
by Kosta Josifidis, Jean-Pierre Allegret and Emilija Beker  
 
The Faculty of Economics Subotica, 2009. 
 
 
 
The choice of a sustainable exchange rate regime in emerging and transition econo-
mies is an essential and complex question in the current context of globalization and 
international financial fluctuations. The book Exchange Rate Regimes in Emerging 
and Transition Economies proposes a comprehensive analysis of this question and 
highlights the economic implications of this choice for countries according to their 
vulnerability to external shocks. The analysis is particularly interesting because the 
positions of emerging and transition economies are studied separately whereas they 
are generally considered in the literature as a single category.  
Moreover, the investigation proposed is complete; the question of the ex-
change rate regime choice is envisaged from a historical, theoretical and empirical 
point of view. The approach is both general, in the field of international macroeco-
nomics, and detailed with the presentation of reference studies; many key contempo-
rary and pioneering concepts are used to treat the overall question. The analysis is 
based on a well-documented literature and underlines the fact that today, while tran-
sition economies tend to prefer fixed exchange rate regimes, emerging ones are in an 
intermediate position. 
The authors point to the fact that traditional macroeconomic criteria are not 
sufficient nowadays to ensure the sustainability of a fixed or quasi-fixed exchange 
rate regime in emerging and transition economies at a national and regional level. In 
addition to fundamental long-run economic stability, it is essential to consider the 
strength of the banking and financial sectors of the country and its dependence on 
developed economies’ macroeconomic evolution. Moreover, political stability is one 
of the main criteria guaranteeing the credibility of the fixed exchange rate regimes in 
these countries. This helps to avoid speculative attacks and the spread of financial 
shocks between countries in periods of international crisis. 
Moreover the authors underline the fact that in a transition economy, when the 
fixed exchange rate regime is not sufficiently sustainable, an exit strategy towards a 
more flexible exchange rate may be adopted. However, this decision must be taken at 
a suitable period in order to limit devaluation pressures on the exchange rate. 
Though the book is moderately technical, the presentation of the theory of ref-
erence is very clear and detailed. It is in the main meant for readers who are special-
ists in macroeconomics and international finance because a good knowledge of the 
major concepts of the literature on exchange rate regimes is needed (postgraduate 
students, researchers, academics and professionals...). However, some parts of the 246  Celine Gimet
PANOECONOMICUS, 2010, 2, pp. 245-249 
book are accessible to a wider audience (chapter I, for example). This approach pro-
poses a high level overview of the problematic and consequently represents a good 
base for research studies concerning exchange rate regime choices in Southeast Asia, 
Latin America, East European and North African countries.  
The book is divided into four different and complementary parts. The first 
three sections constitute a synthesis of the literature on exchange rate regimes, in 
particular in emerging and transition markets. The last section proposes an original 
empirical analysis focusing on monetary and exchange rate regime changes based on 
the cases of Poland, the Czech and Slovak Republics and the Republic of Serbia 
which have recently experienced a transition from a fixed to a flexible exchange rate 
regime.  
The opening section presents the subject in a historical perspective by recal-
ling the evolution of the international monetary system during the 20th century 
(Classical Gold Standard (1880-1914), Gold Standard (1918-1945), Bretton Woods 
(1945-1971) and post-Bretton Woods (1971 until now)). In particular, the rules of the 
Gold Standard and Bretton Woods systems are detailed and the mechanisms required 
for equilibrium adjustment are underlined. Despite the evolution of the international 
monetary system – the countries’ economic and financial openness, the disappear-
ance of common exchange rate rules - the problem of large disequilibria and the 
question of national monetary policy dependence still exist. Thus the objective is to 
shed light on these different exchange rate experiences and to underline the lessons 
that could be drawn from history. However, the main difference is that today, no ex-
plicit or implicit adjustment mechanism exists and the international monetary system 
is not governed by common rules. It seems then that industrialized countries prefer 
extreme exchange rate solutions (monetary union of free floating regimes) whereas 
transition or emerging economies choose intermediate exchange rate arrangements. 
The second part proposes a detailed presentation of the different exchange rate 
arrangements (fixed, intermediate and floating) that can be chosen by countries. The 
authors stress the differences which exist in the implementation of de jure or official 
exchange rate regimes and de facto or applied exchange rate regimes and identify the 
main determinants of the exchange rate regime choices. Fear of floating situations 
are revealed in countries with strong institutions and a credible economic policy and 
fear of pegging ones in countries that suffer from a risk of unsustainability of their 
fixed exchange rate regime. More specifically, the optimal currency area perspective 
is studied from a static and dynamic point of view. The monetary union proposes an 
alternative exchange rate solution. The currency of the countries of the region is 
fixed to a common reference but this reference is flexible on international exchange 
rate markets. This monetary integration concerns the areas that have reached the third 
stage of the Bela Balassa (1961)
1 classification: the common market. The period pre-
ceding the adoption of this type of exchange rate solution is particularly long and 
difficult because it requires an economic, financial and political stabilization and in-
tegration of the countries of the region in order to ensure the sustainability of the fu-
ture exchange rate regime.  
                                                        
1 Balassa, Bela. 1961. The Theory of Economic Integration. Homewood, Illinois: R.D. Irwin. 247  Exchange Rate Regimes in Emerging and Transition Economies - by Kosta Josifidis, Jean-Pierre Allegret and Emilija Beker 
PANOECONOMICUS, 2010, 2, pp. 245-249
In the light of recent crises, monetary union projects in emerging countries are 
taking on a new dimension raising two important questions. The first is to do with the 
ex-ante conditions necessary for setting up a fixed exchange rate arrangement in 
emerging countries which would be sustainable in the long term. The second in-
volves looking at the regional aspect of the problem taking into account possible de-
stabilizing shocks from neighbouring countries. In fact, the main problem linked to 
this type of monetary integration is due to external asymmetric shocks because the 
countries lose their national interest rate and exchange rate as instruments of adjust-
ment in the event of shocks. This is particularly significant in emerging markets. The 
main condition for adopting a sustainable monetary union is the ability of the coun-
tries to resist these shocks. Respecting the traditional criteria of the Optimal Curren-
cy Areas theory (Robert A. Mundell 1961
2; Ronald McKinnon 1963
3; Peter Kenen 
1969
4) is not sufficient nowadays to protect countries against exogenous fluctuations. 
Today these studies must be completed by taking into consideration the changes that 
have taken place since the sixties in the international monetary system, particularly 
with the considerable opening up of financial markets and the extent of exchange 
crises in emerging economies. A study of “third generation” of crisis literature makes 
it possible to complete this set of criteria: in addition to the lasting stability of ma-
croeconomic fundamentals, it is essential to consider the strength of the country's 
banking and financial sectors and the risk of illiquidity in a context of information 
asymmetry. This would help to avoid speculative attacks and the spread of financial 
shocks between countries in the same block during periods of international crisis 
(Giancarlo Corsetti, Paolo Pesenti, and Nouriel Roubini 1999
5; Roberto Chang and 
Andres Velasco 2000
6). But the numerous financial crises that occurred in emerging 
markets at the end of the last century - in Asia in 1997-1998, in Latin America in 
1994, 1999 and 2001 and in Eastern Europe in 1998 and 2001 - have highlighted the 
inability of these countries to adopt this common exchange rate solution.  
However, these episodes of crisis at the end of the last century have raised the 
question of the abandon of a fixed exchange rate in developing countries when they 
experience an outflow of capital and thus some pressure on their exchange rate dur-
ing periods of international fluctuations. This problem makes it necessary to consider 
an exit strategy corresponding to the optimal moment to let the currency float. The 
accent is also put on the need to take into consideration political dimensions, in par-
ticular the influence of private interest groups, political institutions and the electoral 
process. These conditions are decisive in the choice of national and regional fixed 
and quasi-fixed sustainable exchange rate regimes.  
 
                                                        
2 Mundell, Robert A. 1961. “Optimum Currency Areas.” American Economic Review, 51: 509-517. 
3 McKinnon, Ronald. 1963. “Optimum Currency Areas.” American Economic Review, 53: 717-725.  
4 Kenen, Peter. 1969. “The Theory of Optimum Currency Areas: An Eclectic View.” In Monetary Prob-
lems in International Economy, ed. Robert A. Mundell and Alexander K. Swoboda. Chicago: University 
of Chicago Press. 
5 Corsetti, Giancarlo, Paolo Pesenti, and Nouriel Roubini. 1999. ”Paper Tigers? A Model of the Asian 
Crisis.” European Economic Review, 43: 1211-1236. 
6 Chang, Roberto, and Andres Velasco. 2000. “Banks, Debt Maturity and Financial Crises.” Journal of 
International Economics, 51: 169-194. 248  Celine Gimet
PANOECONOMICUS, 2010, 2, pp. 245-249 
The third part focuses on the emerging countries' situation. The vulnerability 
of the countries that adopted intermediate exchange rate regimes during the last epi-
sodes of crisis and the inability to reconcile monetary independence, exchange rate 
stability and complete financial integration (Mundell-Fleming model) promote the 
two corner solution.  But the analysis of the advantages and costs of each type of ex-
treme exchange rate arrangement reveals that these solutions entail the respect of 
conditions which are too restrictive.  In fact, the main advantage linked to a hard peg 
regime (currency board, dollarization) is the gain of credibility for the country, par-
ticularly when it is in a transition stage of development. The exchange rate risk be-
tween the country and its main partners is eliminated and this fosters an increase in 
trade and financial exchanges. However, the cost is very high because the country 
becomes totally dependent on the monetary policy of the country of reference which 
may not correspond to the needs of the domestic economy. Moreover, the sustain-
ability of a fixed exchange rate arrangement involves respecting strict financial and 
banking rules, especially in emerging countries. Exchange rate stability requires the 
country to control the inflow of short-term capital, to limit foreign debt and to keep 
foreign currency reserves high in order to minimize its vulnerability on the interna-
tional market. Besides, recourse to banking loans must be limited, as must be the 
spread between the lending and deposit rates, so as to guarantee the solidity of the 
banking system. 
On the other hand, the flexible regime offers the possibility of reabsorbing the 
external disequilibrium by the exchange rate adjustment. But the independence gains 
depend on the risk of inflation due to depreciation of domestic currency and the vul-
nerability of the domestic interest rate to international fluctuations. Moreover, the 
fear of floating thesis reveals the negative impact of devaluation in emerging coun-
tries.  Consequently, the accent is put on the revival of intermediate regimes in 
emerging economies.  
Finally, the fourth part is devoted to the specific case of the transition econo-
mies that experienced different phases (stabilization, transition and preparatory) be-
fore joining the EU. This is based on an empirical analysis which represents an origi-
nal approach in this book. These different periods are presented and detailed but the 
authors insist on the risks due to a large amount of short term capital inflows at the 
end of the first phase. They measure the advantages and cost of the timely abandon 
of exchange rate regimes as a nominal anchor during this phase when the countries 
experienced some pressure on their exchange rate regime (increase of current deficit, 
real exchange rate appreciation...). The analysis underlines the lower economic cost 
of adopting a transitory flexible exchange rate regime at a favourable moment rather 
than maintaining an unsustainable fixed exchange rate regime during this phase. The 
case of the Republic of Poland, the Czech Republic and the Slovak Republic that let 
their currency float are compared and particular attention is paid to the Serbian situa-
tion. The method selected is a VAR (Vector auto-regression approach) which is 
largely adapted to the study of the influence of the exchange rate regime and makes it 
possible to identify monetary transmission channels in the different cases (exchange 
rate targeting, intermediate exchange regimes and inflation targeting). The presence 
of a cointegration relationship between variables obliges the authors to use a VEC 249  Exchange Rate Regimes in Emerging and Transition Economies - by Kosta Josifidis, Jean-Pierre Allegret and Emilija Beker 
PANOECONOMICUS, 2010, 2, pp. 245-249
approach in some cases. The results are derived from the interpretation of the va-
riance decomposition and the impulse response function. In Poland, the change of 
nominal anchor has been well organized. The exchange rate pass-through is very 
low. Consequently, there is no need to influence exchange rate fluctuations, either 
directly with foreign exchange reserves or indirectly by way of the interest rate. On 
the other hand, in the Czech Republic the movement towards higher flexibility of the 
exchange rate has been difficult and impacted by important depreciation pressure. In 
this country, the highest exchange rate pass-through has been identified. The mone-
tary authorities need to limit exchange rate variations both directly and indirectly, in 
particular through the interest rate channel in the case of inflation targeting. The tran-
sition towards a more flexible exchange rate in the Slovak Republic has been rela-
tively well managed. The authors then focus their interest on the specific case of the 
Serbian economy. The exchange rate pass-through is high, especially when the ex-
change rate is the nominal anchor and in the period of managed floating (first and 
third). The country abandoned a de facto exchange rate as a nominal anchor policy 
and was faced with a complex situation at the beginning of 2008: the need for infla-
tion targeting and the fear of floating problem. Thus different scenarios for the future 
evolution of the economy are proposed. The results therefore underline the fact that 
Poland is the only country that adopted a successful strategy of exchange rate regime 
transition. The strategy of the Czech Republic, the Slovak Republic and Serbia came 
too late. Consequently, the countries have experienced considerable real apprecia-
tion. Thus, to determine the right period for an exit strategy it is necessary to observe 
the growing ratio of nominal shocks (nominal price shocks) relative to real ones 
(productivity shocks) in order to explain real exchange rate variations. 
Although, the book was written just before 2009, the authors conclude by 
placing the problem in the current crisis perspective and underline the main influence 
of the economic and financial evolution of developed countries on developing mar-
kets. A study of the impact of this crisis on emerging and transition economies ac-
cording to the exchange rate regime in place could be the subject of a future book. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 250  Celine Gimet
PANOECONOMICUS, 2010, 2, pp. 245-249 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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