"Effect of Exchange Rate Regime onMacroeconomic Performance[Pick the date]Table of ContentsIntroduction ............................................................................................................................................ 3Conceptualisation ................................................................................................................................... 3Findings ................................................................................................................................................... 4Conclusion ............................................................................................................................................... 6References: ............................................................................................................................................. 9 IntroductionThe economic impact of exchange rate is an important research discussion as it majorly affectsinflation rate and growth of an economy. Economist have extensively researched on its relevance andtested its impact empirically over the years. However, studies revealed different outcomes based ontype of exchange rate regime adopted by the countries, pegged regime showed lower inflation resultsthan the flexible exchange rate regimes. Fixed exchange rate fostered growth, reduced trade withcontrolled inflation due to control by the monetary authorities. Most studies have tried relating growthand inflation to capture exchange rate impact. (Ghosh ,1997) collected data set of 140 countries for aperiod of 1960-90 comparing fixed and flexible exchange rates and studying their behaviourthereafter. Strong negative relationship detected between flexibility and fluctuation in output andemployment, whereas the pegged currencies had higher fluctuations. There are loopholes whilecomputing the impact of regime and commitment stated by bank and the formal definition of floatingand fixed regime.ConceptualisationFixed exchange rate regime is called pegged exchange rate when the countries peg their currencyagainst either a value of another single currency or to a basked of other currencies or gold per se. Theflexible exchange rate helps in stabilizing by setting it to a pre determined ratio and preventing anyInternational fluctuations that may happen. Pegged currency is controlled by reference value whichmay rise or fall and so will the value of the commodities pegged against it. Also in Mundell Flemingmodel where there is perfect capital mobility, fixed exchange rate prevents government from usingmonetary policy to achieve macroeconomic stability. The open market operation where governmentbuys/sells securities is used to maintain pegged ratio, control inflation and behaviour of currency.Over the years the currency type has evolved, earlier gold exchange standard prevailed from 1870 to1914 United Kingdom , Australia, Canada are some of gold standard adopting countries. The Brettonwood brought new exchange rate regime immediately after World War II to stabilize currency. After awhile the system broke down and countries moved to more flexible exchange rate regimes. On theother hand, flexible exchange rate is where monetary system allows exchange rate to be determined by supply and demand. They were followed as currency unions, currency boards and other form ofcurrency pegs. The flexible system experiences time inconsistency and exchange rate volatility,foreign exchange market determines rate and becomes prone to speculative attacks, reduce credibilityof monetary authorities. The third form is pure floating with public sector intervention whereexchange rate movements help adjust to shocks and reduce need to hold reserves.Data Study [Calvo (1990) ,Hanke and Schuller (1999)]suggested fixed exchange rate regime to have both prosand cons using example of full dollarization but were also held responsible for International economicfailures. For developing countries decision over exchange rate is important because it decides strengthof currency, inflation rate and volatility risk of the currency. This choice is different for developedcountries having sound and more authoritative fed roles. The turnover rate of central banks governor ,central bank independence , appointment of governor and lending limit of central bank was alsoconsidered as a measure of endogeneity in the study conducted by (Cukierman,1992). During 1960spegged currency countries had lower inflation rate which shifted to higher inflation rate under flexibleexchange regime. But the observations were not sufficient to explain relative macroeconomicperformance of the countries. Pegged exchange rate also seemed to have raised money demandbecause of uncertain monetary policy. Previous studies have used dummy variables with outputgrowth , inflation rate, interest rate regime, and other proxies to represent open economy cases[Romer(1993) , Lane (1994)]. The results showed five percentage point lower inflation in floatingregimes with various excluded variables, results represented high output growth rate and greateropenness reduced inflation. [Guitian (1994) and Dornbusch (1994)] have tried to empirically linkexchange rate and macroeconomic performance , applying the same to various economies.Findings The paper examined showed how exchange rate regime did not make a difference on the inflation rateand when countries moved to floating regime not much changes were recorded as they were not readyto adopt an intermediate regime. There was no exchange rate assumed to be superior to another but policy type and the implementation did impact the variables. After 1970s when countries shifted fromsingle to basket of currencies and more flexible rate arrangements countries like Albania, Romania,have flexible regime against countries like Czech republic, Slovakia went more fixed with othersusing a crawling peg system. Studies suggested countries to adopt intermediate regimes though theyled to capital mobility. Balance of payments showed inflow in the emerging economies increasedfrom 1989 but declined after 1998.Pegged rates were preferred for more stable domestic and financialpolicy response and reduced volatility from International markets. Whereas, Proponents of fixedexchange rate opposed flexible rates saying that they reduced volume of International trade andinvestments. The floating regime helps a country to use an independent policy where economyaccommodates both domestic and international shocks like interest rate fluctuations. But fixedexchange rate fosters inflation but gives more credibility for the policy makers. There have also beenmulti country studies to capture nominal exchange rate effects during 1960-89, and proving lowerinflation under fixed exchange rate regime. This paper also included endogeneity in choice ofexchange rate which was a major drawback in making empirical suggestions. Countries with fixedrate reported higher current account deficit but had exceptions too. Fiscal performance in fixed regimehas not improved much compared to intermediate regimes. Also the ratio of International reservescompared to monetary is lower in floating countries, ‘impossible trinity’ has also been referred byeconomists to suggest that countries cannot attain monetary independence, exchange rate stability,financial integration all at the same time. Stability in terms of political decision making has alsochanged the way countries choose to peg their currencies, also countries with lower growth rate andcapital inflexibilities have preferred much rigid exchange rate regimes. Countries wanting moreopenness with the external markets have adopted flexible regimes for better adjustments.With fixed regime monitoring cost of government and fed is much higher in terms of monetarygrowth and its effect on interest rates on the economy. [Elitza Mileva and Livio Stracca ,(2016)] triedrepresenting how real exchange rate has effected economic growth and showed impact on real percapita growth rate for a period of over 5years after Bretton woods and proved stronger impact ondeveloping countries yet again. Overvaluation hampered growth and undervalue was seen as a better instrument for promoting growth as it leads to more domestic saving and investments. Previousstudies have noticed errors because exchange rate regimes impact is exogenously determined. Thecapital accumulation trade policies do change the way an economy works, it is not clear if developingcountries should a maintain a weaker exchange rate to promot growth because it impacts themdomestically, due to this government pay attention to the exchange rate movements than just setting it.ConclusionThe exchange rate regime is more significant for budget balance of a country, credibility, inflationrate and to check ease of capital movement between countries. Fixed exchange rate enhancescredibility for countries but may not allow massive International trade and foreign investmentopportunities, but they have a high level of reserves to keep the currency from fluctuations and curbinflation. Developing countries still suffer credibility, with limited international transaction and sharein market become more volatile during trade. When countries have larger reserve to monetary baseratio it shows how easily a country can move out of fluctuations both in floating and fixed regimeswhich also reflects on their credibility. Most of the studies reflected upon how exchange rate wasimpactful on the inflation rate especially the floating ones. Fixed regime increased investment becausethen the political stability is higher, volatility is lower and the interest rate is lower which is mostimportant while undertaking investment decisions. Also switching from floating regime tointermediate one can help reducing inflation but the reverse causes higher inflation with moredomestic investment and capital flight from countries. Intermediate regimes in poorer economies hadmaximum inflationary results with higher monetary growth, better capital movement kept inflation incontrol .Thus, investors do count on the regime followed by the countries as it impacts their decisionof investing , lower returns would mean capital outflow and loss in trust of countries credibility forinvestment. But still there is no significant study to suggest if there is any particular regime suggestedto be appropriate for a sound performance of a country. Fixed exchange rate helps curbing inflationbecause countries become more credible and earns investor trusts, but too much control is also "