Fear of Declaring: Do Markets Care What Countries Say About Their Exchange Rate Policies?

Sturzenegger (2001), there has been growing recognition of a disconnect between what emerging economies say they do in exchange rate policy (words), and what they do in practice (deeds). More specifically, a ‘‘fear of floating’’ behavior has been identified, whereby countries that classify themselves as floating exchange rate regimes intervene quite vigorously over time. While many persuasive arguments have been offered as to why countries intervene, the question remains as to why intervening countries continue to classify their regimes as floating. Thus, concurrently with fear of floating, there seems to be a ‘‘fear of declaring.’ ’ This paper examines one possible reason for fear of declaring: that international capital markets might reward countries that are classified toward the flexible end of the spectrum. Based on the JPMorgan Emerging Market Bond Index spread, we use a panel data approach that exploits both time and cross-country variability. With some qualifications, we find that spreads are lower in countries that have a fixed exchange rate regime, whether de jure or de facto, implying that there is no evidence that markets punish fear of floating. One possible explanation for this puzzle—that is, countries intervene but say that they do not, even though markets appear to be, Adolfo Barajas is a senior economist and Lennart Erickson an economist with the IMF Institute; Roberto Steiner is a research associate with Fedesarollo in Colombia. This paper is dedicated to the memory of Taras Chernetsky. The authors thank the participants at the IMF 2007 Research Conference and at the IMF Institute seminar for discussions that led to key improvements in this study, most particularly the discussant for the paper, Carmen Reinhart. Thanks as well go to Radu Pãun for outstanding and patient research assistance. Finally, the authors thank the two anonymous readers for their thoughtful comments and suggestions. This paper is dedicated to the memory of Taras Chernetsky