Handbook of Exchange Rates

28.4 How to Weigh Up the Advantages of Fixing Versus Floating

Which dominate: the advantages of fixing or the advantages of floating? Empirical attempts to evaluate performance are hampered by the fact that de facto exchange rate regimes frequently differ from de jure: countries do not in practice follow the regime that they have officially declared. Many governments that say they float in fact do not float.¹⁵ Many governments that say they peg do not in fact hold the peg for long.¹⁶ Many governments that say they follow some version of a basket, in fact fiddle surreptitiously with the weights in the basket.

Some studies have attempted to classify countries according to their de facto exchange rate regime and then to test which categories have superior economic performance, judged by growth and other measures. This literature is entirely inconclusive. To oversimplify the findings of three important studies only a little: Ghosh et al. (2000) found that hard pegs work best, Levy-Yeyati and Sturzenegger (2001, 2003) concluded that floats perform best, and Reinhart and Rogoff (2004) found that limited flexibility is best!

Why such different answers? There are two major reasons, one relatively more pedestrian and the other more enlightening. First, the de facto classification schemes do not correspond to each other. A country's currency may be classified by one author as pegged and by another as floating.¹⁷,¹⁸ To that extent, it is no surprise that the authors get different answers ...