Economic Convergence and Exchange Rate Regimes

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Economic Convergence and Exchange Rate Regimes

• Mehmet Yörükoglu
• Central Bank of Republic of Turkey

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Emerging Markets
All Countries Excluding Emerging Markets
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Question

• Why do emerging market economies prefer floating
  exchange regime more than others do?

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Outline

• Strong preference of emerging economies for
  flexible exchange rate regime.
• History and dynamics of convergence.
• Balassa-Samuelson effect and real exchange rate
  appreciation during convergence.
• Discussion about the problems about fixing (even
  managing) the exchange rate during the
  convergence process.
• Other possible explanations for the flexibility
  preference.
• Conclusions

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Global Economic Divergence Growth of Per Capita
GDP for 114 Countries, 1960-1990
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Labor Productivity and CPI Decomposition in
Croatia
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Labor Productivity and CPI Decomposition in
Slovakia
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Labor Productivity and CPI Decomposition in
Czekh Republic
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Labor Productivity and CPI Decomposition in
Hungary
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Labor Productivity and CPI Decomposition in
Poland
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Labor Productivity and CPI Decomposition in
Euro Area
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Other Possible Explanations

• Fixed exchange rate as a nominal anchor for
  monetary policy may not be that relevant for
  emerging economies.
• Moreover, EME may prefer flexible exchange rate
  regime in order to fight against inflation more
  aggresively
• Fixed exchange rate regime as a prevention for
  competitive depreciation may less of an issue now
  for emerging economies.
• Advances in IT may have reduced the potential
  volatility under flexible exhange rate regime.

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Conclusions

• Emerging market economies experience significant
  real exchange rate appreciation during the
  convergence process.
• In an environment where real exchange rate is
  expected to have a positive trend maintaining a
  fixed exchange rate regime may be very difficult
  and costly.
• This may be why more and more emerging market
  economies prefer a flexible echange rate regime.

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Classification of Exchange Rate Regimes
1/ Excludes tightly managed floats