Exchange Arrangements Entering the 21 st Century: Which Anchor Will Hold? Ethan Ilzetzki LSE Carmen M Reinhart Kenneth Rogoff Harvard University Bank of Israel, December 7, 2017
Overview Introduce new and updated classification of anchor currencies and exchange arrangements USD dominant anchor / benchmark currency World has not moved to greater ERA flexibility Bretton Woods II: Dooley et al (2003) Anchor currency classifications shed further light on new Triffin Dilemma. Farhi, Gourinchas & Rey (2011), Obstfeld (2013), Farhi & Maggiori (2016)
METHODOLOGY
Sketch of ERA Algorithm Use monthly absolute value of change in exchange rate. With respect to 10 candidate anchors/benchmark. Freely falling Peg Narrow band Managed float Freely floating Inflation > 40% for 12 months 0 variation for 4 months <2% variation over 2 year rolling window Within99% CI of variation among anchors
Sketch of Anchor Algorithm Freely falling/floating: no anchor Peg / Narrow band: anchor unambiguous Managed float: Single candidate anchor with smallest variation >50% of observations = anchor. If none: use non exchange rate criteria
Benchmark Currency Selection Process: Additional Criteria Benchmark Currency Index: Average of four measures: 1. Reserve denomination (% reserves in currency X) 2. Trade invoicing (% of X+M invoiced in X) 3. Denomination of (external public) debt (% denominated in currency X) 4. Previous anchor (1/y, where y is the number of years since anchored to currency X.)
Benchmark Currency Selection Process: Additional Criteria Country Years $ index index Benchmark Brazil 2001-62% 4% USD Canada 2001-35% 5% USD Chile 2008-48% 9% USD Colombia 2008-71% 0% USD Iceland 2001-23% 19% Marginal India 2012-63% 7% USD Israel 2005-37% 12% USD Korea 1999- USD Latvia 1998-2001 EUR Turkey 1998-40% 25% USD Uruguay 2009- USD
Existing Classifications Exchange Arrangements: Reinhart and Rogoff (2004) Shambaugh (2004) Levi-Yeyati and Sturtzenegger (2005) IMF (annually) Anchor Currencies: Frankel and Wei (1994) for E. Asia First to integrate anchor classification formally with ERA classification.
MODERN HISTORY: ANCHOR CURRENCIES
Summary of Findings The dollar retains its dominant position as the world s reserve currency. By some metrics it is as dominant as it was at the time of the early Bretton Woods era. By other metrics, its global role has expanded: Collapse of the ruble zone Re-anchoring of freely falling Classification consistent with other measures of dollar dominance and provides summary measure of anchor currency based on revealed preference.
Post-World War II Major Anchor Currencies Share of countries, 1946-2015, excludes freely falling cases 100 Percent 90 80 70 60 UK pound 50 40 30 20 US dollar French franc and German DM (1946-1998) and Euro (1999-2015) 10 0 1946M1 1956M1 1966M1 1976M1 1986M1 1996M1 2006M1
The Geography of Anchor Currencies, 2015
Stress Test: Whatever it takes, 2012 0% -2% $ Anchor Borderline -4% -6% Non-$ Anchor -8% Appreciation vs. $: Smaller when classified as anchored -10% Jul-2012 Aug-2012 Sep-2012 Oct-2012 Nov-2012 Dec-2012 Jan-2013 /$
/$ Exchange Rate 1.5 1.4 "Taper Tantrum" FRB Tightening signal 1.3 1.2 1.1 "Whatever it takes" 1.0 2010 2011 2012 2013 2014 2015 2016
Markers of an Anchor Currency
Markers of an Anchor Currency
MODERN HISTORY: EXCHANGE ARRANGEMENTS
Summary of Findings Oft cited global transition from fixed to floating exchange rates considerably overstates the reality. Based on ERA classification for 194 countries over 1946-2016 IMF classification of all Eurozone member countries as having floating ER since 2007 contributes to the overstatement. Lower incidence of bi-polar or corner solutions (Stanley Fischer, 2001)
De Facto ERA 1946-2016 Share of (independent) countries in each group Groups 1 and 2: Less flexibility, primarily nominal exchange rate anchors Percent 100 90 Group 2: Gradualist adjustment (from crawling peg to narrow crawling bands) 80 70 60 50 40 30 20 Group 1: Least flexible (from no separate legal tender to de facto pegs) 10 0 1940 1950 1960 1970 1980 1990 2000 2010
De Facto ERA 1946-2016 Share of (independent) countries in each group Groups 3 and 4: Flexible, incl. most inflation target arrangements 100 Percent 90 80 70 60 50 40 Group 4: Freely floating (few high-income cases) 30 Group 3: Broad bands and managed floating 20 10 0 1940 1950 1960 1970 1980 1990 2000 2010
De Facto ERA 1946-2016 Share of (independent) countries in each group Groups 5 and 6: Freely falling & multiple ER Percent 100 90 80 70 60 50 40 Group 6: Multiple, Dual, or parallel markets with limited or no data on the structure of exchange rates Group 5: Freeely falling, inflation > 40% or currency crash 30 20 10 0 1940 1950 1960 1970 1980 1990 2000 2010
The Geography of Exchange Rate Arrangements, 2015
TRIFFIN DILEMMA
Summary of Findings A modern Triffin Dilemma may be in the Making. Increasing dominance of USD anchor Continued inflexibility of ERAs Reserve accumulation substituting capital controls (per theoretical analysis of Korinek, 2013) But US declining share of global GDP
Exchange Rate Arrangements and Capital Mobility, 1946-2016 90 80 Share of countries with less flexible exchange rate regimes 70 60 50 40 30 20 Share of countries with dual/multiple/parallel exchange rates 10 0 1946 1956 1966 1976 1986 1996 2006 2016
World Reserves minus Gold (US dollars) % of US GDP 1948-2015 Percent 140 120 Reserves minus gold/ US GDP 100 The Bretton Woods system 80 World 60 40 20 Emerging and Developing countries 0 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012
Role of the Dollar and US Economy 1950-2015 Share of countries 70 60 50 40 30 20 US GDP as a share of world GDP (percent, right scale) Share of countries where the US dollar is the principal anchor currency (percent, left scale) 30 28 26 24 22 20 18 16 14 12 10 1950M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1 Reinhart 10
Role of the Franc & DM 1950-1998, and Euro 1999-2015 30 28 26 France and Germany GDP as a share of world GDP (percent, right scale) 12 10 24 22 8 20 6 18 16 14 12 Share of countries where the euro (and previously the French franc and DM) are the principal anchor currency (percent, left scale) 4 2 10 1950M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1 0
Role of the Pound and the UK Economy 1950-2015 30 7.0 6.5 25 6.0 20 Share of countries where the UK pound is the principal anchor currency (percent, left scale) 5.5 5.0 15 4.5 4.0 10 5 UK GDP as a share of world GDP (percent, right scale) 3.5 3.0 2.5 0 1950M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1 2.0
Role of the Yen and Japanese Economy 1950-2015 10 9 Japan GDP as a share of world GDP (percent, right scale) 10 9 8 8 7 7 6 6 5 5 4 4 3 2 Share of countries where the yen is the principal anchor currency (percent, left scale) 3 2 1 1 0 1950M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1 0
Chinese Economy 1950-2015 18 16 14 12 10 China GDP as a share of world GDP (percent, right scale) 8 6 4 2 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Conclusions USD as dominant as anchor today as ever. RMB is the wildcard. No substantial move to ER flexibility. Increase in intermediate de-facto regimes. New Triffin Dilemma may be on the horizon.
APPENDIX 1: HOW TO CLASSIFY EZ COUNTRIES?
Classifying the Eurozone Eurozone >10% of World GDP Poses classification challenge floating externally EZ countries no legal tender internally IMF classify all EZ countries freely floating We classify all as no legal tender
Classifying the Eurozone Unit of observation is sovereign country No EZ member has more than 4% voting share Trade: >60% of trade is internal Consistency in time series EZ has moved to less monetary autonomy
Classifying the Eurozone: Evidence
Estimating Taylor Rules
1.2 Taylor Rule Coefficients: Inflation Germany only country to satisfy Taylor principle Taylor principle violated for EZ as whole 1 0.8 Whiskers: 95% confidence intervals 0.6 0.4 0.2 0-0.2
Taylor Rule Coefficients: Output Gap 1.5 But monetary policy has been countercyclical for most countries Whiskers: 95% confidence intervals 1 0.5 0-0.5
Calculating Taylor Rules
Taylor Rule vs. Policy Rate 12% 10% 8% 6% DM DM Regime Regime Rule 12% 10% 8% 6% DM DM Regime Regime Rule 4% 4% 2% 0% Policy 2% 0% Policy 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 12% 10% DM DM Regime Regime 8% 12% 10% DM DM Regime Regime 8% 6% 4% 2% 0% 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-2% -4% Rule Policy 6% 4% 2% 0% 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-2% Rule Policy
Germany 12% 10% DM DM Regime Regime 8% Rule 6% 4% 2% Policy 0%
France 12% 10% DM DM Regime Regime 8% 6% Rule 4% 2% Policy 0%
Portugal 12% 10% DM DM Regime Regime 8% 6% Rule 4% 2% Policy 0% -2% -4%
Eurozone 12% 10% DM DM Regime Regime 8% 6% Rule 4% 2% Policy 0% -2%
Summary No clear break in policy in 1999 ECB follows DM Taylor rule closely until 2008 Post crisis ECB playing stabilizing role for EZ, but little to suggest that doing so for for any individual member
APPENDIX 2: ARE INFLATION TARGETERS DIFFERENT?
Inflation Targeting One of the biggest developments in dejure monetary arrangements As we will show: IT not particularly informative Masks heterogeneity in exchange arrangements in practice.
Inflation Targeters Managed / Freely floating Or wide bands Crawling pegs
Monetary Practices of IT Central Banks
Augmented Taylor Rule Estimates Unbalanced Panel 1990-2015 Regression Results w. Country Fixed Effects Dependent Variable = Nominal Interest Rate 1 2 3 4 5 Inflation.68***.67***.74***.74***.73*** (.014) (.015) (.017) (.017) (.017) Log(Exchange Rate) 2.24*** 2.03*** 1.99*** 1.60*** (.144) (.147) (.150) (.150) Unemployment.10***.07*** (.017) (.017) Commodity Price Inflation 1.00 Inflation*"Fixed" (.628) Fixed IT: Less aggressive on inflation -.19*** -.19*** -.18*** (.026) (.026) (.026) Log(Exchange Rate)*"Fixed" Fixed IT: More aggressive on.34***.36***.34*** exchange rate (.053) (.053) (.054) Commodity Price Inflation*"Fixed".22 (.168) R 2 0.32 0.35 0.36 0.36 0.36 n 4717 4666 4665 4574 4529
Stress Testing ER Classification of IT Central Banks Consider two major shocks: 1. Lehman, September 2008 2. FRB signalling tightening cycle in June 2014
Lehman 2008 100 100 95 95 90 90 85 85 80 80 75 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 NON-IT 1+2 IT 1+2 NON-IT 3+4 IT 3+4 75
102 Fed Tightening Announcement 2014 102 100 100 98 98 96 96 94 94 92 92 90 90 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 NON-IT 1+2 IT 1+2 IT 3+4 NON-IT 3+4
14 Lehman 2008 Inflation 12 10 8 6 4 2 0 2008 2009 May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec NON-IT 1+2 NON-IT 3+4 IT 1+2 IT 3+4
7 Fed Tightening Announcement 2014 Inflation 6 5 4 3 2 1 0 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 NON-IT CAT 1+2 NON-IT CAT 3+4 IT CAT 1+2 IT CAT 3+4
Summary IT masks heterogeneity in exchange rate practices Our ERA classification gives information that goes beyond the IT headline Pegged IT central banks less aggressive on inflation & more on exchange rate Similar exchange rate behaviorto non-it pegged currencies in face of major shocks. But inflation is lower in IT countries, even those with a dual mandate
APPENDIX 3: ANCHOR AND ERA ALGORITHMS
ER Arrangement Classification Algorithm Sequence and general scheme
ER Arrangement Classification Algorithm Statistical tests
Anchor Currency Selection Process
APPENDIX 4: CAPITAL CONTROLS
Summary of Findings Introduce an index of exchange restrictions As a minimal measure of capital controls. Global trend towards increased capital mobility. A fairly modern phenomenon for emerging and developing countries.
Index of Exchange Restrictions This index takes on the value 1 if any one or more of the following conditions hold and 0 otherwise. There is a de-jure dual market / multiple exchange rates OR There is a de-facto parallel market and the parallel premium >10% over 12-month moving average. Sources: IMF AEAER, Franz Pick. Index = 1 is sufficient but not necessary for capital controls.
Share of Independent Countries with Dual, Multiple, or Parallel Exchange Rates, January 1950-September 2016: 90 Advanced economies 80 70 60 Share of countries(solid line) 50 40 30 Share weighted by GDP (dashed line) 20 10 0 1950M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1
Share of Independent Countries with Dual, Multiple, or Parallel Exchange Rates, January 1950-September 2016: All independent countries 100 90 80 70 60 Share of countries (solid line) 50 40 30 20 Share weighted by GDP (dashed line) 10 0 1950M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1