Do fixed exchange rates act as a cushion for emerging markets?

Abstract

Fixed exchange rate or the pegged exchange rate regime is a regime in which the exchange rate of a country is tied to the currency of another currency or to a basket of currencies. Whereas floating exchange rate or a flexible exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. In today s scenario of integrated global economies, it becomes utmost crucial for countries to decide on what sort of exchange rate regime they want to follow as it can make a big difference to other macroeconomic variables in the economy and ultimately can affect the economic development of the country. Some instances of fixed exchange rate working to the detriment of the countries adopting the same are mentioned below.1. The Oil producing countries had a fixed exchange rate to the US Dollar in 1970 s.Owing to high inflation in the United States, the dollar was devalued against the Deutsche Mark. This devaluation resulted in the oil becoming expensive for United States, which further pushed up inflation.2. The Asian tigers (Thailand, Malaysia, Indonesia, the Philippines, Singapore, and South Korea) had fixed exchange rate regime. This fuelled their growth in the 1980 s and early90 s, due to the relatively high interest rates. Also, as these were export led economies, the fixed exchange rate worked in their favor. But, the large current account deficits of these countries were unsustainable and led to a devaluation of the currencies in 1997,leading to the Asian crisis. As we see above, the fixed exchange rate has been partially responsible for the high inflation and the oil crisis in the United States in the 1970 s, as well as the Asian crisis in1997. But does that mean that fixed exchange rate are always detrimental to the economies in this era of globalization. May be No. We with this project intend to study one such instance i.e. does fixed exchange rates act as a cushion for effect in markets in emerging economies because of change in developed markets. In this process we would also like to analyze the reasons behind countries moving fixed to flexible exchange rates.