Fear of Floating: Exchange Rate Flexibility Indices

An exchange rate flexibility index There is no single all-encompassing indicator that provides an adequate measure of the extent of exchange rate flexibility allowed by the monetary authorities. Yet from the model developed in Section III, we can motivate the construction of a multivariate index that captures different manifestations of the extent of exchange rate variability relative to the variability of the instruments that are at the disposal of the monetary authorities stabilize the exchange rate. As noted earlier, domestic reserves, R, can also be expressed in terms of their asset counterparts, which includes foreign exchange reserves, F. As the results of the F-tests attest to, reserve variability is significantly higher for the less committed floaters than for the benchmark countries. Furthermore, it is well known that foreign exchange market intervention is commonplace in many of the cases studied here. For this reason, in the empirical application of the model we focus on a variance ratio that looks at the central bank balance sheet from the asset side, implying that equation (19) should be modified to, the values λ can take on range from zero, when there is a peg or a ver high degree of commitment to inflation targeting, to 1 when seignorage has a high weight in the policy maker’s objective function. As shown in Table 4, in about 83 percent of the cases the index of exchange rate flexibility is below that of Australia--for Japa