Exchange rate regime choice and currency crises

Exchange rate regime choice is not exogenous, but it depends on the structural, political and financial features of countries. However, it is often the case that the regime actually pursued and the one that is imposed by country features do not match one to one. The existing empirical crisis models do not take fully into account the regime in which the crisis unfolded. The aim of this paper is to incorporate the appropriateness of the regime choice into the standard currency crisis model. The results show that the odds of crisis increase significantly in countries which have chosen regimes inconsistently.

► Pursuing a regime that is inconsistent with a country's features increases the odds of currency crises. ► In crisis-hit peggers and floaters especially, regime determinants actually imposed different regimes than those at work. ► Overvaluation of RER and output gap, as expected, posed problems for more rigid exchange rate regimes. ► Contagion effects are observed in the making of crises across all regimes, but for floaters they are more pronounced. ► Capital account openness decreases the odds of crisis, an indication of the discipline imposed by liberalized financial markets.