Exchange Rate Regimes and Business Cycle Synchronization

Jia Hou and Jakub Knaze

Open Economies Review, 2022, vol. 33, issue 3, No 6, 523-564

Abstract: Abstract This paper studies the effect of seven types of exchange rate regimes on business cycle synchronization, by using a new dataset on bilateral de-facto exchange rate regimes for the 1973-2016 period. Using the extreme bounds analysis (EBA) methodology, we find that the exchange rate regime is a robust determinant of business cycle synchronization. We find that, compared to country pairs with freely floating arrangements, (i) the correlation coefficient measuring business cycle synchronization is higher by approximately 0.07-0.12 points in countries with no separate legal tenders; (ii) the effect does not always linearly decrease with increasing exchange rate regime flexibility, since the effects of crawling pegs and crawling bands turn out to be insignificant, whereas that of moving bands as a more flexible type of exchange rate regime is positive and significant; and (iii) the effect is stronger for countries with a high degree of financial openness and good institutional quality. The second finding suggests that the role of intermediate exchange rate regimes is more complicated than previously recognized in the literature and deserves more attention. In addition, we find that (iv) the positive effect of interest is more prominent for countries from the high-income group, in contrast to the occasionally negative effect of some regimes for other country pairs, and that (v) specialization and fiscal policy integration are factors that influence the effect of exchange rate regimes on business cycle synchronization.

Keywords: Exchange rate regimes; Currency unions; Business cycles synchronization; E32; E52; F33; F42 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s11079-021-09648-0

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