Why Do Countries Float the Way They Float?

40 Pages Posted: 21 Apr 2011

See all articles by Ricardo Hausmann

Ricardo Hausmann

Harvard University - Harvard Kennedy School (HKS)

Ugo Panizza

Graduate Institute of International and Development Studies (IHEID) - Department of Economics; CEPR

Ernesto Stein

Inter-American Development Bank (IDB)

Multiple version iconThere are 3 versions of this paper

Date Written: May 2000

Abstract

Countries that are classified as having floating exchange rate systems (or very wide bands) show strikingly different patterns of behavior. They hold very different levels of international reserves and allow very different volatilities in the movements of the exchange rate relative to the volatility that they tolerate either on the level of reserves or in interest rates. We document these differences and present a model that explains them as the optimal response of a Central Bank that attempts to minimize a standard loss function, in an environment in which firms are credit-constrained and incomplete markets limit their ability to avoid currency mismatches. This model suggests that the difference in the way countries float could be related to their differing levels of exchange rate pass-through and differences in their ability to avoid currency mismatches. We test these implications and find a very strong and robust relationship between the pattern of floating and the ability of a country to borrow internationally in its own currency. We find weaker and less robust evidence on the importance of pass-through to account for differences across countries with respect to their exchange rate/monetary management.

Suggested Citation

Hausmann, Ricardo and Panizza, Ugo and Stein, Ernesto Hugo, Why Do Countries Float the Way They Float? (May 2000). IDB Working Paper No. 349, Available at SSRN: https://ssrn.com/abstract=1817216 or http://dx.doi.org/10.2139/ssrn.1817216

Ricardo Hausmann (Contact Author)

Harvard University - Harvard Kennedy School (HKS) ( email )

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Ugo Panizza

Graduate Institute of International and Development Studies (IHEID) - Department of Economics ( email )

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CEPR

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Ernesto Hugo Stein

Inter-American Development Bank (IDB) ( email )

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Research Department
Washington, DC 20577
United States

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