The Art of Gracefully Exiting a Peg

Abstract

The wave of liberalisation of capital movements, which swept Europe in the 1980s and the emerging market countries in the 1990s, has given rise to the two-corner strategy. This strategy, expounded e.g. by Eichengreen (1994) and Fischer (2001), holds that only two exchange rate regimes are sustainable: hard pegs (currency boards, dollarisation) and fully flexible rates. Soft pegs in the middle, the traditional fixed but adjustable exchange rate regimes as well as all varieties of crawling bands, are seen as doomed, open to irresistible and unpredictable speculative attacks. While the predominance of the two corners remains open to the observation that most countries fear both extremes (see e.g. Levy-Yeyati and Sturzenegger, 2002), it remains true that an increasing number of countries have exited the soft middle ground, mostly towards the flexible end of the spectrum.