Verifiability: A Rationale for the Failure of Intermediate Exchange Rate Regimes
30 Pages Posted: 30 Mar 2000
Date Written: February 8, 2000
This paper offers a possible theoretical rationale ? currently lacking -- for the proposition that intermediate exchange rate regimes are no longer viable. According to this proposition, countries are being pushed to the "corners," the extremes of either free floating or firm fixing. We introduce the notion of 'verifiability,' by which we mean the ability of a market participant to infer statistically from observed data that the exchange rate regime announced by the authority is in fact in operation. Verifiability is a means to credibility. Our point is that a simple regime may be more verifiable by market participants than a complicated intermediate regime. We study the verifiability of exchange rate regimes by analyzing the case of Chile and by performing Monte Carlo simulations. Simple pegs and basket pegs are relatively easy to verify. As the case of Chile helps illustrate, a band around a peg makes the verification more difficult. Under a narrow band the weights on the central parity can be estimated correctly. However, wider bands make impossible the verification of the central parity. The amount of data that would be required may well exceed the length of the time period during which a given regime is typically maintained. The Monte Carlo exercise shows that the amount of information necessary to verify the exchange rate regimes increases with the complexity of the regime, including the width of the band and the number of currencies in the basket.
Keywords: exchange rate regimes, corners, basket peg, band, target zone, verifiability, transparency, Chile
JEL Classification: F31, F32, F33, F36
Suggested Citation: Suggested Citation