Is reserve volatility inversely related to exchange rate flexibility?

Michael Bleaney and Mo Tian

No 2020/04, Discussion Papers from University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM)

Abstract: When the pressure on the exchange rate is high, the government has to consider how much to resist such a speculative attack by spending reserves rather than allowing the exchange rate to change. Some authors have claimed that the best approach to classifying exchange rate regimes is to estimate to what extent exchange market pressure (EMP) is absorbed in reserve variability rather than exchange rate variability. Empirical evidence is presented on the variability of reserves and exchange rates over a large sample of countries from 1980 to 2019. Pegged regimes do not display any more reserve volatility than floats. In most regimes there is a small but statistically significant positive correlation between reserve accumulation and exchange rate appreciation in monthly data, but this effect is no stronger in less flexible regimes, where intervention is expected to be greater. An EMP-inspired flexibility index is constructed, based on the ratio of exchange rate flexibility to reserve volatility, and the two flexibility measures are compared by investigating their conformity with the IMF de facto classification. The EMP-inspired flexibility index does not improve the identification of pegs, but it helps to distinguish free floats from managed floats. Most likely this is because credible pegs need little intervention to support them.

Keywords: exchange rates regimes; inflation (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:not:notcfc:2020/04

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