Currency regimes and external competitiveness: the role of institutions, trade agreements and monetary frameworks

Abstract

Abstract The literature lacks consensus on the role of currency regimes in explaining external competitiveness. Countries not only differ in terms of currency regimes, but can also have different institutional arrangements, namely trade agreements and inflation targeting (IT) frameworks in addition to the overall quality of governance. Hence, using the real effective exchange rate and by covering 35 developing countries over the period 1975–2014, we investigate the role of currency regimes in explaining the degree of misalignment while considering institutional factors. First, we find that intermediate regimes limit the currency misalignment with greater financial openness (FO). Second, non-reciprocal preferential trade agreements improve price competitiveness, whereas free trade and reciprocal ones can only be beneficial with a higher degree of FO. Third, misalignments in fixed regimes decline in the presence of stronger institutions or in countries with an IT type of monetary policy framework. The above results remain robust to alternative specifications.