Shock Persistence and the Choice of Foreign Exchange Regime - an Empirical Note from Mexico

20 Pages Posted: 20 Apr 2016

See all articles by Shahidur R. Khandker

Shahidur R. Khandker

World Bank - Development Research Group (DECRG)

Rashid Faruqee

World Bank

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Date Written: July 31, 2000


The academic and policy debate about optimal foreign exchange rate regimes for emerging economies, has focused more on the theoretical costs and benefits of possible regimes, than on their actual performance. The authors report on what can be called exchange-rate-regime-dependent differential shock persistence - that is, the time output takes to return to its trend after a negative shock - in a sample of countries representing various points on the spectrum of nominal foreign exchange flexibility. They find strong evidence that Mexico's stimulated output recovery after a negative external shock was faster (a third as long) when the country's policymakers let the nominal foreign exchange rate float, than when they fixed it, and much faster than in other developing countries that kept nominal foreign exchange rates constant, especially those that resorted to currency board arrangements to support that constancy. These results are insufficient to guide the choice of regime (they lack general equilibrium value, and are based on a limited sample of countries), but they highlight an important practical consideration in making that choice: How long it takes for output to adjust after negative shocks, is sensitive to the level of rigidity of the foreign exchange regime. This factor may be critical when the social costs of those adjustments are not negligible.

Keywords: Environmental Economics & Policies, Macroeconomic Management, Banks & Banking Reform, Economic Stabilization, Economic Theory & Research, Fiscal & Monetary Policy, Payment Systems & Infrastructure

Suggested Citation

Khandker, Shahidur R. and Faruqee, Rashidur R., Shock Persistence and the Choice of Foreign Exchange Regime - an Empirical Note from Mexico (July 31, 2000). World Bank Policy Research Working Paper No. 2371, Available at SSRN:

Shahidur R. Khandker (Contact Author)

World Bank - Development Research Group (DECRG) ( email )

1818 H. Street, N.W.
Washington, DC 20433
United States

Rashidur R. Faruqee

World Bank ( email )

1818 H Street, N.W.
Washington, DC 20433
United States

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