New perspectives on international debt and exchange rates.

• Author: Rogoff, Kenneth S.
• Position: Research Summaries

My research over the past couple of years has focused on rethinking international debt and exchange rates, particularly, but not exclusively, for developing countries.

A Revised History of Exchange Rates

The choice of exchange rate regime remains one of the most controversial issues in international macroeconomic policy today and--in the eyes of most policymakers and policy economists--one of the most critical. Yet, curiously, much academic work, pioneered by NBER researchers Marianne Baxter and Alan Stockman (1), has shown that it is difficult to prove that the exchange rate regime systematically affects economic growth or, for that matter, any macroeconomic variable other than the real exchange rate. At the same time, it is equally difficult to identify any stable systematic relationship between macroeconomic variables (including policy variables such as interest rates and budget deficits) and major currency exchange rates, at least for horizons up to two years. Richard Meese and I first identified this puzzle in a pair of papers in 1983 (2) and it has stood up to numerous attempts to overturn it since. In a 2000 paper, (3) Maurice Obstfeld and I summarize the thin connection between exchange rates and macroeconomic variables as the "exchange rate disconnect puzzle."

Why have researchers found it so difficult to show that exchange rate regimes matter when policymakers and business people take the connection for granted? Carmen Reinhart and I (4) offer one possible rationale. We note that, in comparing the performance of fixed and flexible exchange rate regimes, researchers typically have had to rely on the official history of exchange rates, a sterilized picture that is often sharply at odds with reality. That is, most comparisons of fixed and floating regimes have been based on the International Monetary Fund's official historical classification of exchange rates which, until very recently, has tended to passively reflect what countries report they are doing to the IMF. If a country like China, which has a virtually pegged exchange rate, reports to the IMF that it is engaged in "managed floating", then (until recently) the IMF database would dutifully record China as engaged in a variant of floating. A related problem is that many countries claiming to have "fixed" exchange rates succeed in doing so only by imposing severe capital controls. Pervasive controls, in turn, typically lead to either a large parallel ("black") market for foreign exchange or, in other instances, to an official dual market. As a result, there are surprisingly many cases historically where countries reported their exchange rates as fixed while actually following a monetary and exchange rate policy much more commensurate with floating. Although developing countries have dominated this category in recent decades, backdoor floating characterized many major European countries' exchange rate regimes for the first half of the Bretton Woods period of "fixed exchange rates."

Reinhart and I develop an algorithm for reclassifying exchange rate regimes going back to 1946; our approach takes neither a country's official declared exchange rate regime nor its officially declared...