The Effects of Currency (Exchange Rate) Regimes

In the recent years, the effect of globalization has been increasing rapidly, while making each economy to be dependent to another economy. A change in one economic variable in a specific country started to affect another country regardless of whether they have common boundary or not. Therefore, the economic variables have been monitored by every country and they try to take proactive decisions in order to prevent the effects of negative events that are predicted to happen in the near future.

This shows that the countries are very curious about what will happen in the near future. Moreover, it has been proven that different variables have different types of relationships. This makes the relationship between different economic variables to be understood clearly and accurately. It is for sure that this will ease the studies of the economists who are trying to estimate future events and their possible effects in local economy.

Foreign exchange rates are determined under different types of foreign exchange regimes which are being applied by different countries depending on their requirements and political structures. These were classified as hard peg regimes, soft peg regimes, intermediate exchange rate regimes and finally the floating regimes. Each of these exchange rate regimes have own characteristics, structures and consequences. For example while we are expecting inflation to be taken under control under soft peg regimes, a foreign currency crisis might also happen. These pros and cons are valid for each type of regimes.

It was proved that the countries tend to apply hard peg and floating rate regimes rather than soft peg regimes. The hard peg regimes were questioned because of their bad causes and lose of the national currency (in the dollarization) which represents the symbol of sovereignty and independence. Therefore, dollarization may not be convenient for the countries whose inhabitants are known for their nationalism.

When we come to soft peg regimes, we can say that all of them are used for maintaining stability and competitiveness, reducing the interest rates, providing a clear and easily monitorable nominal anchor and reducing inflation. These will help the economy to perform well in the future. But, the regimes under soft peg should be supported by structural reforms done by government. If these reforms are not completed, it means that the country will be open for currency crises provided that the country is open to international markets since the national money is re-valued. The foreign debts and imports become cheaper and this increases the short positions in all sectors and also the trade deficit of the country. Turkey has suffered from one of the soft peg regime which is called as crawling peg in 2000 and the crisis occurred in February 2001.

The last type of foreign exchange rate regimes is the floating regimes. The main advantage is it allows a country to adjust itself to external shocks through the exchange rate fluctuations where the shocks are absorbed by the economy with daily exchange rate movements. The value of the currency unit comes to its real price depending on the other economic variables. Nevertheless, in the other exchange rate regimes, it takes time for the currency to find its real value. Sometimes, it doesn’t find its value under different types of peg regimes so a big crisis occurs and the real price is settled after a big devaluation. This was seen in Turkish economy finally in 2001 crisis. The USD rate went up to 964,000 TL from 689,000 TL in one day. The devaluation was around 40%.

When we have looked into the exchange rate regimes, it was understood that there is no unique or best exchange rate regime for each country. This is also proven by different exchange rate mechanisms that are applied by different countries. It shows that, there is a need or problem in the country and for that specific need or problem a different exchange rate regime is applied.