Much like Mark Twain, reports of the death of fixed exchange rates have been exaggerated. It seems each time a peg collapses, there is a clamoring that “soft pegs” are unsustainable in today’s big bad world of rapid capital movement. Pegs, it is often noted, are fragile. And yet, when we look around, there always seem to be plenty of pegs – ready targets for complaints of exchange rate misalignment or predictions of collapse.
In recent work (The Dynamics of Exchange Rate Regimes: Fixes, Floats, and Flips – Journal of International Economics, forthcoming, NBER Working paper no. 12729), Michael Klein and I note a few important regularities regarding the dynamics of pegs. First, many are in fact fragile (only 40% of pegs that start make it 3 years or more), but once they settle in, they tend to last (86% of pegs that last 3 years make it at least one more).
But, it is our observation about floats that is relevant to the post title. Floats are as fragile as pegs. That is, once a peg is broken – and a float begins – about half will reform a new peg within 3 years. In fact, despite the spectacular collapses in the last decades, there are now more sustained pegs (those lasting at least 5 years) than at any time since the early 1970’s.
In general, a large number of countries are now pegged that at some point were recently floating. Taking the most spectacular crisis recently as an example: Argentina’s currency board collapsed in early 2002 and its exchange rate ranged over 130% against the dollar in 2002 and still had a range of movement of 19% in 2003 (that is it was ranging within + or – 10% bands). But, by 2004-5 it was what we might call a loose peg (a range of +/- 3%) and by 2006 was tightly moving within +/- 2% bands as a true peg. Just glancing around Latin America, there are the obvious examples of El Salvador and Ecuador adopting the dollar as their currency, but there are plenty of others who have pegged more conventionally lately. Bolivia tightened the bands of its currency in 2004 and it is now a true peg to the dollar. Guatemala, Honduras, and Uruguay have all narrowed their bands to now move within +/- 2% bands against the dollar. All three were not tightly pegged at the start of the century, but are now. Costa Rica, Mexico, and Peru are loose pegs with bands that have been narrowing, and Nicaragua has a crawling peg to the dollar. All these countries pegged at some point, saw their pegs break, and have now reformed to some extent – many to full fledged pegs.
In short, the death of the peg appears over-rated, but in part because even when pegs die, they are frequently reborn. Many of those listed will possibly break in the near future (some may have since I downloaded the data a few months ago) but others will likely reform.
For those interested in this topic, see the paper with Michael Klein listed above and the citations in it. Much of the data is also available on my website. Michael and I are currently writing a book on this topic and many others relating to exchange rate regimes – look for it from MIT Press in a year of so.