EXCHANGE RATE REGIMES AND INFLATION PERFORMANCE IN DEVELOPING COUNTRIES

Michael BLEANEY (University of Nottingham) Manuela FRANCISCO (University of Nottingham)

According to theory, pegging an exchange rate is associated with lower inflation rates through two mechanisms: the disciplinary effect on monetary policy and the confidence effect of influencing inflation expectations. There has been only limited empirical research on this issue.

Three classifications methodologies based on IMF reported exchange rate arrangements are used for a sample of 102 developing countries for the period 1984 to 2000.

Over the whole period "hard pegs" (currency boards, CFA) have significantly lower inflation than "soft" pegs. Basket pegs have lower inflation than "soft" single pegs and there is no significant difference between managed and independent floats.

Floating exchange rates are associated with higher inflation than "soft" pegs, but since 1996 the difference has been very small. Although many more developing countries floated their exchange rates in the 1990s than in the 1980s, average inflation has decreased because inflation has fallen sharply amongst floating rate countries.

The relationship between monetary growth and exchange rate regimes resembles that for inflation. There is no significant difference in the average budget deficit between "soft" pegs and floating. In the 1980s budget deficits were significantly lower for hard pegs.

A switch from peg to floating is followed by an increase in inflation in the majority of cases we study. The inverse switch leads to a decrease in inflation, although in just a few cases.