# Link between the exchange rate regime and banking, currency and debt crises occurrence.

JEL F30 * G01

The choice of the exchange rate regime (ERR) is one of the most critical questions facing economies, as it has a great impact on their development, financial stability, effectiveness of monetary and fiscal policies and interdependence with the global financial system. While the ultimate decision depends on a number of economic and political factors, it is also of great importance to take into account its crisis susceptibility, especially in the highly integrated global economy with increasingly volatile capital flows. This paper empirically investigates the existence and magnitude of the impact of alternative ERRs on the likelihood that a banking, currency or debt crisis will occur in the economy. The author puts forward the following two hypotheses: (1) a choice of a flexible ERR rather than fixed or intermediate regimes diminishes the likelihood that the three types of financial crisis (currency, debt and banking crises) occur in the country; and (2) intermediate regimes are more prone to financial crisis occurrence as compared to the corner options. To test the hypotheses, the author uses a comprehensive data set including 51 developed and developing countries over 2000-2012. In order to assess the degree to which different currency regimes are prone to three types of financial crisis, the author employs the following econometrical model:

[Crisis.sub.it] = [[beta].sub.0] + [[beta].sub.1]*[ERR.sub.it] + [[beta].sub.2]*[X.sub.it] + [[epsilon].sub.it]

where X is a matrix of control variables that might influence the likelihood of the onset of a particular type of crisis in country i at time t, ERR is a dummy variable encoded in three different ways depending on the hypothesis checked, and Crisis is a dummy variable coded as "1" if country i undergoes a crisis at time t and "0" otherwise.

The three types of crises, currency, banking and external/internal debt, are treated separately, one by one. With the help of a binary logit model, a log-odds ratio of, for example, banking crisis can be expressed as follows:

ln Prob(banking) = 1/Prob(banking) = 0 = [[beta].sub.0] + [[beta].sub.1]*[ERR.sub.it] + [[beta].sub.2]*[X.sub.it]

where [[beta].sub.2] measures the change in the log-odds ratio of a banking crisis occurrence for a unit change in [X.sub.it]. [[beta].sub.1] measures the change in the log-odds ratio of a banking crisis occurrence as the ERR dummy variable changes from "0" to "1", which can be interpreted differently depending on the encoding of the ERR dummy:

1. ERR as "1 " if country i is under hard peg and free float at time t and "0" otherwise (all intermediate): adopting either hard peg or free float rather than intermediate results in an increase of [[beta].sub.1] points in the log-odds ratio of a banking crisis occurrence, holding all other variables constant.

2. ERR as "1" if country i is under hard peg at time t and "0" under floating and free-floating: adopting hard peg rather than float or free-float results in an increase of [[beta].sub.1], points in the log-odds ratio of banking crisis occurrence, holding all other variables constant.

3. ERR as "1" if country i is under hard peg at time t and "0" under intermediate and floating: adopting hard peg rather than intermediate or floating results in an increase of [[beta].sub.1] points in the log-odds ratio of banking crisis occurrence, holding all other variables constant.

In a similar way, the author defines changes in the log-odds ratio for currency and debt crises. The main empirical findings indicate that adopting a fixed exchange rate diminishes the likelihood of occurrence of the three types of crisis, thus strongly rejecting the first hypothesis. The second main result is that intermediate regimes are not more prone to financial crisis. Rather, they are more immune than corner regimes to currency and banking crises. Thus, the author rejects the claim that intermediate regimes are more vulnerable to banking and currency crises. However, the author supports the hypothesis that intermediate regimes are more prone to debt crisis.

DOI 10.1007/s11293-015-9460-8

Published online: 19 May 2015

Mayia Samuilik (1)

[mail] Mayia Samuilik

mayia.samuilik@gmail.com

(1) Economics, Lazarski University, Swieradowska 43, Warszawa, Poland 02-662

The choice of the exchange rate regime (ERR) is one of the most critical questions facing economies, as it has a great impact on their development, financial stability, effectiveness of monetary and fiscal policies and interdependence with the global financial system. While the ultimate decision depends on a number of economic and political factors, it is also of great importance to take into account its crisis susceptibility, especially in the highly integrated global economy with increasingly volatile capital flows. This paper empirically investigates the existence and magnitude of the impact of alternative ERRs on the likelihood that a banking, currency or debt crisis will occur in the economy. The author puts forward the following two hypotheses: (1) a choice of a flexible ERR rather than fixed or intermediate regimes diminishes the likelihood that the three types of financial crisis (currency, debt and banking crises) occur in the country; and (2) intermediate regimes are more prone to financial crisis occurrence as compared to the corner options. To test the hypotheses, the author uses a comprehensive data set including 51 developed and developing countries over 2000-2012. In order to assess the degree to which different currency regimes are prone to three types of financial crisis, the author employs the following econometrical model:

[Crisis.sub.it] = [[beta].sub.0] + [[beta].sub.1]*[ERR.sub.it] + [[beta].sub.2]*[X.sub.it] + [[epsilon].sub.it]

where X is a matrix of control variables that might influence the likelihood of the onset of a particular type of crisis in country i at time t, ERR is a dummy variable encoded in three different ways depending on the hypothesis checked, and Crisis is a dummy variable coded as "1" if country i undergoes a crisis at time t and "0" otherwise.

The three types of crises, currency, banking and external/internal debt, are treated separately, one by one. With the help of a binary logit model, a log-odds ratio of, for example, banking crisis can be expressed as follows:

ln Prob(banking) = 1/Prob(banking) = 0 = [[beta].sub.0] + [[beta].sub.1]*[ERR.sub.it] + [[beta].sub.2]*[X.sub.it]

where [[beta].sub.2] measures the change in the log-odds ratio of a banking crisis occurrence for a unit change in [X.sub.it]. [[beta].sub.1] measures the change in the log-odds ratio of a banking crisis occurrence as the ERR dummy variable changes from "0" to "1", which can be interpreted differently depending on the encoding of the ERR dummy:

1. ERR as "1 " if country i is under hard peg and free float at time t and "0" otherwise (all intermediate): adopting either hard peg or free float rather than intermediate results in an increase of [[beta].sub.1] points in the log-odds ratio of a banking crisis occurrence, holding all other variables constant.

2. ERR as "1" if country i is under hard peg at time t and "0" under floating and free-floating: adopting hard peg rather than float or free-float results in an increase of [[beta].sub.1], points in the log-odds ratio of banking crisis occurrence, holding all other variables constant.

3. ERR as "1" if country i is under hard peg at time t and "0" under intermediate and floating: adopting hard peg rather than intermediate or floating results in an increase of [[beta].sub.1] points in the log-odds ratio of banking crisis occurrence, holding all other variables constant.

In a similar way, the author defines changes in the log-odds ratio for currency and debt crises. The main empirical findings indicate that adopting a fixed exchange rate diminishes the likelihood of occurrence of the three types of crisis, thus strongly rejecting the first hypothesis. The second main result is that intermediate regimes are not more prone to financial crisis. Rather, they are more immune than corner regimes to currency and banking crises. Thus, the author rejects the claim that intermediate regimes are more vulnerable to banking and currency crises. However, the author supports the hypothesis that intermediate regimes are more prone to debt crisis.

DOI 10.1007/s11293-015-9460-8

Published online: 19 May 2015

Mayia Samuilik (1)

[mail] Mayia Samuilik

mayia.samuilik@gmail.com

(1) Economics, Lazarski University, Swieradowska 43, Warszawa, Poland 02-662

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Title Annotation: | ANTHOLOGY |
---|---|

Author: | Samuilik, Mayia |

Publication: | Atlantic Economic Journal |

Article Type: | Report |

Geographic Code: | 1USA |

Date: | Jun 1, 2015 |

Words: | 708 |

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