On Becoming More Flexible: Exchange Rate Regimes in Latin America and the Caribbean

Introduction

Following the collapse of the Bretton Woods System of fixed exchange rates in 1973, most developing countries continued to peg the value of their currencies to the currency of their major trading partners. Since then, there has been a dramatic shift toward more flexible exchange rate regimes among countries in Latin America and the Caribbean (LAC). In 1978, 73% of these countries maintained pegged exchange rates relative to the U.S. dollar. This percentage had fallen to just 23% by mid 1994.

The primary objective of this paper is to examine why countries in the region have shifted between fixed and more flexible regimes. A simple model of exchange rate regime choice is developed, and estimated using probit analysis for 26 countries during 1978-92. The approach followed here is to distinguish between two broad types of exchange rate regime: fixed and more flexible, where the latter category includes a variety of regime types. However, problems with exchange regime classification introduce important caveats to all of the empirical analyses of regime choice, including this one, as discussed further below. The paper also takes a preliminary look at whether choice of exchange rate regime “matters” for macroeconomic performance—and especially for economic growth—in developing countries. Because available data make a systematic analysis difficult, the discussion highlights potential pitfalls in drawing conclusions about the linkages.