Economic Convergence
and
Exchange Rate Regimes
Mehmet Yörükoğlu
Central Bank of Republic of Turkey
Number of Emerging Markets
1990 1995 2000
Fixed
Intermediate
Floating
7
2
15
6
1
19
3
6
17
2005
1
4
21
Number of Countries Excluding Emerging Markets
1990 1995 2000 2005
Fixed
Intermediate
Floating
80
16
35
62
14
78
44
52
64
Emerging Markets (% Share)
1990 1995 2000
46
54
58
Fixed
Intermediate
Floating
29.2
8.3
62.5
23.1
3.8
73.1
11.5
23.1
65.4
2005
3.8
15.4
80.8
All Countries Excluding Emerging Markets (% Share)
1990 1995 2000 2005
Fixed
Intermediate
Floating
61.1
12.2
26.7
40.3
9.1
50.6
27.5
32.5
40.0
29.1
34.2
36.7
Emerging Markets
100%
25
21
# of Countries
80%
19
20
90%
17
70%
15
62.5
73.1
60%
15
65.4
80.8
50%
10
40%
7
5
6
6
3
2
30%
4
1
20%
1
10%
0
8.3
3.8
29.2
23.1
23.1
15.4
11.5
0%
1990
1995
Fixed
2000
Intermediate
2005
1990
Floating
1995
Fixed
Intermediate
2000
3.8
2005
Floating
All Countries Excluding Emerging Markets
100%
80
80
78
70
90%
64
62
# of Countries
60
54
52
50
16
40.0
36.7
32.5
34.2
27.5
29.1
2000
2005
12.2
9.1
40%
30
20
70%
50%
35
40
58
50.6
60%
46
44
26.7
80%
30%
14
61.1
40.3
20%
10
10%
0
0%
1990
Fixed
1995
Intermediate
2000
Floating
2005
1990
1995
Fixed
Intermediate
Floating
Question:

Why do emerging market economies prefer
floating exchange regime more than others
do?
Outline






Strong preference of emerging economies for
flexible exchange rate regime.
History and dynamics of convergence.
Balassa-Samuelson effect and real exchange rate
appreciation during convergence.
Discussion about the problems about fixing (even
managing) the exchange rate during the
convergence process.
Other possible explanations for the flexibility
preference.
Conclusions
Global Economic Divergence
Growth of Per Capita GDP for 114 Countries,
1960-1990
Labor Productivity
and
CPI Decomposition in Croatia
Labor Productivity
and
CPI Decomposition in Slovakia
Labor Productivity
and
CPI Decomposition in Czekh Republic
Labor Productivity
and
CPI Decomposition in Hungary
Labor Productivity
and
CPI Decomposition in Poland
Labor Productivity
and
CPI Decomposition in Euro Area
10.2006
07.2006
04.2006
01.2006
10.2005
07.2005
04.2005
01.2005
Mexico
10.2004
07.2004
04.2004
01.2004
10.2003
07.2003
Chile
04.2003
01.2003
10.2002
07.2002
04.2002
Brazil
01.2002
10.2001
07.2001
04.2001
01.2001
10.2000
07.2000
04.2000
01.2000
Emerging Markets (Latin America) REER Index (Jan 2000=100)
160
Turkey
150
140
130
120
110
100
90
80
70
For Russia: Data ends in October 2006
10.2006
07.2006
04.2006
01.2006
Russia
10.2005
07.2005
04.2005
Poland
01.2005
10.2004
07.2004
04.2004
Hungary
01.2004
10.2003
07.2003
04.2003
Czech Rep
01.2003
10.2002
07.2002
04.2002
01.2002
Bulgaria
10.2001
07.2001
04.2001
01.2001
10.2000
07.2000
04.2000
01.2000
Emerging Markets (Eastern Europe) REER Index (Jan 2000=100)
190
Turkey
180
170
160
150
140
130
120
110
100
90
80
10.2006
07.2006
Thailand
04.2006
01.2006
10.2005
07.2005
04.2005
Malaysia
01.2005
10.2004
07.2004
04.2004
S. Korea
01.2004
10.2003
07.2003
04.2003
01.2003
Indonesia
10.2002
07.2002
04.2002
01.2002
10.2001
China
07.2001
04.2001
01.2001
10.2000
07.2000
04.2000
01.2000
Emerging Markets (Asia) REER Index (Jan 2000=100)
150
Turkey
140
130
120
110
100
90
80
70
10.2006
07.2006
04.2006
01.2006
10.2005
07.2005
04.2005
01.2005
10.2004
07.2004
04.2004
01.2004
10.2003
S. Africa
07.2003
04.2003
01.2003
10.2002
07.2002
Nigeria
04.2002
01.2002
10.2001
07.2001
04.2001
01.2001
10.2000
07.2000
04.2000
01.2000
Emerging Markets (Mid. East & Africa) REER Index (Jan 2000=100)
160
Turkey
150
140
130
120
110
100
90
80
70
60
I. Successful Fixed Exchange Rate Management
“Gradual Adjustment”
(Not very likely)
Real Exchange Rate
Preconvergence
Convergence
Fixed rate
Flexible rate
revaluation
Time
I. Successful Fixed Exchange Rate Management
“Gradual Adjustment”
(Not very likely)
Convergence
Inflation
Preconvergence
Time
I. Successful Fixed Exchange Rate Management
“Gradual Adjustment”
(Not very likely)
Convergence
FX Reserves and
steriization costs
Preconvergence
Time
I. Successful Fixed Exchange Rate Management
“Gradual Adjustment”
(Not very likely)
Convergence
Trade Deficit
Preconvergence
Time
I. Successful Fixed Exchange Rate Management
“Gradual Adjustment”
(Not very likely)
Convergence
Interest Rate
Preconvergence
Time
II. Successful Fixed Exchange Rate Management
“One-Shot Adjustment”
(Not very likely)
Real Exchange Rate
Preconvergence
Convergence
Fixed rate
Flexible rate
revaluation
Time
II. Successful Fixed Exchange Rate Management
“One-Shot Adjustment”
(Not very likely)
Convergence
Inflation
Preconvergence
Time
III. Unsuccessful Fixed Exchange Rate
Management
“Overshooting”
(very likely)
Real Exchange Rate
Preconvergence
Convergence
Revaluation,
overshooting
Fixed rate
Flexible rate
Time
Other Possible Explanations




Fixed exchange rate as a nominal anchor for monetary policy
may not be that relevant for emerging economies.
Moreover, EME may prefer flexible exchange rate regime in
order to fight against inflation more aggresively
Fixed exchange rate regime as a prevention for competitive
depreciation may less of an issue now for emerging economies.
Advances in IT may have reduced the potential volatility under
flexible exhange rate regime.
Conclusions



Emerging market economies experience significant
real exchange rate appreciation during the
convergence process.
In an environment where real exchange rate is
expected to have a positive trend maintaining a
fixed exchange rate regime may be very difficult
and costly.
This may be why more and more emerging market
economies prefer a flexible echange rate regime.
Classification of Exchange Rate Regimes
1/ Excludes tightly managed floats