____PS 24212
POLICY RESEARCH WORKING PAPER   2424
Global Transmission                                                 Hikes in U.S. interest rates in
1999-2000 have started to
of  Interest  Rates                                                 spill over to other economies'
interest rates, which in many
countries have risen to reflect
the higher U.S. rates. Are
and  the  Currency  Regime                                          countries with flexible
exchange rates better able to
Jeffrey Frankel                                                      isolate their domestic interest
Sergio Scbmukler                                                    rates from this type of
Luis Serven                                                         negative international shock?
Less and less so, as
economies become more
integrated.
The World Bank
Development Research Group
Macroeconomics and Growth
and
Latin America and the Caribbean Region
Chief Economist Unit
August 2000



POLICY RESEARCH WORKING PAPER 2424
Summary findings
Frankel, Schmukler, and Serven empirically study the         to 1), even for several countries with floating regimes.
sensitivity of local interest rates to international interest  The data suggest an upward time trend in the degree to
rates and how that sensitivity is affected by a country's    which domestic interest rates are sensitive to
choice of exchange rate regime.                              international capital movements and developing
To establish the empirical regularities, they use a        economies' increased financial integration with the rest
reduced-form empirical approach to compute both panel    of the world.
and single-country estimates of interest rate sensitivity      As a result, country-specific estimates for the 1990s
for a large sample of developing and industrial              reveal few cases of less-than-full transmission of
economies between 1970 and 1999.                             international interest rates to domestic rates, regardless
When using the full sample, they find that:                of the currency regime.
* Interest rates are typically lower in economies with       Country-specific results suggest that only large
fixed exchange rates than in those with flexible exchange    industrial countries can (or choose to) benefit from
rates.                                                       independent monetary policy. During the 1990s, interest
* More rigid currency regimes tend to exhibit higher       rates in European countries were fully sensitive to
transmission than more flexible regimes.                     German interest rates but insensitive to U.S. interest
In many cases in the 1990s, however, the authors           rates.
cannot reject full transmission (a slope coefficient equal
This paper-a joint product of Macroeconomics and Growth, Development Research Group, and the Chief Economist
Unit, Latin America and the Caribbean Region-is part of a larger effort in the Bank to understand the functioning of
alternative currency arrangements. Copies of the paper are available free from the World Bank, 1818 H Street NW,
Washington, DC 20433. Please contact Emily Khine, room MC3-347, telephone 202-473-7471, fax 202-522-3518, email
address kkhine@worldbank.org. Policy Research Working Papers are also posted on the Web at www.worldbank.org/
research/workingpapers. The authors may be contacted at jeffrey_frankel@harvard.edu, sschmukler@worldbank.org, or
lserven@worldbank.org. August 2000. (33 pages)
The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about
development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The
papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this
paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the
countries they represent.
Produced by the Policy Research Dissemination Center



Global Transmission of Interest Rates:
Monetary Independence and Currency Regime4
Jeffrey Frankel
Harvard University and NBER
Sergio Schmukler
World Bank
Luis Serven
World Bank
JEL Classification Codes: F3 1, F32, F33, F36
Keywords: interest rates, exchange rate regime, currency regime, monetary
independence, monetary policy
4 We thank Jorge Streb and participants at the June 2000 conference on Currency Regimes,
www.worldbank.org/lacconferences, for very useful comments. We are grateful to Andrea Bubula,
Eduardo Fajnzylber, Changqing Sun, Nong Thaicharoen, and Hairong Yu for excellent research assistance.
We also thank Atish Ghosh and Holger Wolf for generously providing us with their data. The World Bank
LAC Regional Studies Program provided financial support for this research. The findings, interpretations,
and conclusions expressed in this paper are entirely those of the authors and do not necessarily represent
the views of the World Bank, its Executive Directors, or the countries they represent.
E-mail addresses: jeffrey frankel(Pharvard.edu, sschmukler(qworldbank.orn. lserven(.worldbank.org






1. Introduction
As has also been true in past episodes of global monetary tightening, 1999-2000
hikes in U.S. interest rates were rapidly reflected in interest rate increases in other
industrial and developing economies. In emerging markets, the increases were in several
cases proportionally larger than those experienced in the US, presumably because country
and/or currency risks increased after the Fed decided to tighten US monetary policy.
Even though the pressure to increase interest rates was felt virtually across the board, one
question remains unanswered: are countries with flexible exchange rates more able to
isolate their domestic interest rates from this type of negative international shock? This
issue of monetary independence, which lies at the heart of the debate on currency
arrangements, is the central question of this paper.
The choice of exchange rate regime-floating, fixed, or somewhere in between-
has been a recurrent question in international monetary economics. According to the
conventional view, the two major advantages of fixing the exchange rate are: (1) reduced
transactions costs and exchange rate risk, that can discourage trade and investment, and
(2) a credible nominal anchor for monetary policy.
The advantages of a flexible exchange rate, on the other hand, can generally be
described under one major property: it allows the country to pursue independent
monetary policy.   The argument in favor of monetary independence, instead of
constraining monetary policy by the fixed exchange rate, is the classic argument for
discretion instead of rules. When the economy is hit by a disturbance, such as a shift in
To be sure, other factors enter as well. Two other advantages of an independent currency are that the
government retains seignorage, and floating allows smooth adjustment to real shocks even in the
presence of price frictions. Most of the important factors, however, can be lumped into the major
arguments presented in the text.
1



worldwide demand away from the goods it produces, the government would like to be
able to respond, so that the country does not go into recession. Under fixed exchange
rates, monetary policy is always diverted, at least to some extent, to dealing with the
balance of payments. Under the combination of fixed exchange rates and complete
integration of financial markets, which characterizes the European monetary union,
monetary policy becomes completely powerless.2 By freeing up the currency, on the
other hand, the country can respond to a recession by means of monetary expansion and
depreciation of the currency. This stimulates demand for domestic products and returns
the economy to desired levels of employment and output, more rapidly than would be the
case under the automatic mechanisms of adjustment on which a fixed-rate country must
rely.3
According to the traditional arguments, under pegged exchange rates and
unrestricted capital flows, domestic interest rates cannot be set independently, but rather
must track closely those prevailing in the country to which the domestic currency is
pegged. By contrast, under a flexible exchange rate arrangement, the domestic interest
rate should be less sensitive to changes in international interest rates-other things equal.
Countries with intermediate regimes should also display less sensitivity to international
interest rates than countries with firm pegs.
However, an alternative view-stated, among others, by Calvo and Reinhart
(2000a and 2000b) and Hausmann, Panizza, and Stein (2000)-holds that there exists
2 An expansion in the money supply has no effect: the new money flows out of the country, via a balance
of payments deficit, just as quickly as it is created. In the face of an adverse disturbance, the country
must simply live with the effects. After a fall in demand, for example, the recession may last until
wages and prices are bid down, or until some other automatic mechanism of adjustment takes hold.
3For a more complete exposition of the advantages and disadvantages of alternative exchange rate regimes,
see Frankel, Schmukler, and Serven (2000).
2



"fear of floating," that prevents countries with de jure flexible regimes from allowing
their exchange rates to move freely. According to this view, factors like lack of
credibility, exchange rate pass-through, and foreign-currency liabilities prevent countries
from pursuing an independent monetary policy, regardless of their announced regime.
Therefore, many countries, even if formally floating, are de facto "importing" the
monetary policy of major-currency countries, much as those with pegs.
Although monetary independence has been at the heart of the debate on exchange
rate regimes, empirical evidence on the issue is still scarce. In particular, there are few
empirical studies on whether floating exchange rate regimes do indeed allow independent
monetary policy, in the sense that interest rates in countries with floating regimes are less
sensitive to foreign interest rates. Focusing on currency boards and some floating
regimes, Borensztein and Zettlemeyer (2000) find some evidence consistent with the
traditional view. On the other hand, selected country evidence during the 1990s-
reported in Frankel (1999) and Hausmann, Gavin, Pages, and Stein (1 999)-is consistent
with the alternative view.
The goal of this paper is to establish the major empirical regularities concerning
the sensitivity of domestic interest rates to international interest rates under different
currency regimes. To do this, we analyze existing experiences from the widest possible
spectrum of regimes, from full exchange rate flexibility to currency boards. Thus, the
paper should help place the ongoing debate in the context of the observed facts, and allow
3



an assessment of the competing claims cited above on the relative merits of alternative
exchange rate arrangements from the perspective of monetary independence.4
The paper extends the empirical literature in several directions. First, while
previous studies have been limited to a handful of countries over short time periods, here
we consider a much larger data set in both the cross-country and time-series dimensions,
by working with a sample of industrial and developing countries over the last three
decades. Second, we test the robustness of the results to changes in sample coverage.
We present estimates both .for the overall sample as well as subsamples of industrial and
developing countries and different time periods. Third, to deal with the inaccuracies of
standard exchange rate regime classifications, we also present empirical results for
selected countries, whose exchange arrangements are generally regarded as more clear-
cut than the rest. Finally, even though we work mainly with US rates as our primary
indicator of "foreign interest rates," we also take into account the emergence in recent
years of other currency areas, most notably the Deutsche mark-European Monetary
Union (DM-EMU) zone. Thus, we examine the sensitivity of European interest rates to
German interest rates.
The rest of the paper is organized as follows.  Section 2 introduces the
methodology and data used in this paper. Section 3 presents pooled estimation results by
exchange rate regime, income group, and decade. Section 4 takes a closer look at the
evidence from individual countries. Section 5 summarizes the results and concludes.
The Appendix describes the exchange rate regimes in each country in the sample.
4 There is an extensive literature that studies the merits of different exchange rate regimes in other
dimensions. For example, Ghosh, Gulde, Ostry, and Wolf (1996) analyze the behavior of inflation
and growth under alternative exchange rate arrangements.
4



2. Methodology and Data
In principle, there are several factors that determine the extent to which domestic
and foreign interest rates move together.  The first one is the degree of financial
integration of the domestic economy into world markets. For example, as described in
Kaminsky and Schmukler (2000), barriers to international capital flows can dampen the
response of local interest to changes in international rates. Second, the degree of real
international integration also matters for the comovement of domestic and foreign interest
rates-if business cycles are highly synchronized across countries, domestic and foreign
rates will tend to move closely together, given other things. Third, the nature of shocks
also contributes to determine the degree of comovement.  Unlike country-specific
idiosyncratic shocks, common shocks-such as financial and climatic-affect many
countries simultaneously, what tends to be reflected in closer correlation of interest rates,
for given degrees of intemational real and financial integration.
Our primary concern here, however, is to establish the empirical regularities
regarding the overall link between local and foreign interest rates, rather than sorting out
the role of each of the above factors. Thus, we focus on the estimation of a simple
reduced-form specification of the type
r,,t = f + r +r3< X+X    +,,      (1)
where i = 1.N and t = 1.T. Here r,' represents the domestic nominal interest rate in
local currency of country i at time t;f is a country-specific effect;5 r,<is the international
interest rate; and Xi,, is a set of control variables. We assume that the error term ej  has
5



mean zero and is independently distributed across countries, but is possibly
heteroskedastic and serially correlated.
We experimented with two sets of control variables X,,. The first one includes
only the difference between the domestic and foreign inflation rates.6 We do this because
much of the variation in nominal interest rates across countries and over time may just
reflect variation in inflation rates, which is quite substantial in our sample.
Next, we added into Xi, a set of dummy variables to control for turbulent periods,
when the sensitivity of local interest rates to foreign ones may differ from its "normal"
value. Specifically, we used three dummies. The first one is a "crisis" dummy that,
following the literature on exchange rate crises, takes a value of one when the cumulative
depreciation of the nominal exchange rate over a three-month period is equal to or greater
than 15 percent. The second is a hyperinflation dummy that takes a value of one when
monthly inflation is above 50 percent, and zero otherwise. Finally, the third is a
"transition" dummy to control for changes in the exchange rate regime-specifically, exit
from pegs to other regimes. Since such exits tend to be accompanied by considerable
financial turbulence, in the absence of controls the new regime may be unduly associated
with higher or more volatile interest rates and inflation, among other things.7  The
transition dummy takes a value of one in the month of the transition as well as those
5 Note that time specific effects cannot be included, because they would be perfectly collinear with r; .
6 All interest rates and inflation rates x are defined as In (I +x). We also experimented with a somewhat
more general version including separately domestic and foreign inflation, rather than entering them as
a differential. Results with this broader specification, however, showed that in general the differential
specification was not rejected by the data.
7This is noted, for example, by Edwards and Savastano (1999).
6



immediately preceding and following it.8  To allow  some additional flexibility in our
specification, we also interacted the three dummies with the foreign interest rate. On the
whole, the empirical results obtained including the dummies were quite similar to those
from the specification with inflation alone, and hence to save space we only report the
latter below.9
We estimate equation (1) separately for each currency regime, since preliminary
evidence showed that neither the country effects nor the coefficients on the control
variables were equal across regimes.  For each regime, we are interested in two
parameters, characterizing respectively the sensitivity of the local interest rate to the
foreign rate (,B in equation (1) above), and the average level of the local interest rate after
controlling for the other factors. The latter can be summarized by a parameter ax, defined
as:
N
a=-sfEfi ,
that is, the average of the country-specific effects under the regime in question.'°
We present two types of estimates. In section 4, we report pooled fixed-effect
estimates, combining all the available information as well as grouping countries by
income level and breaking the sample by decade (1970s, 1980s, and 1990s), to see if
8 We also experimented with other specifications enlarging the transition period and dropping the
corresponding observations. Likewise, we used different variations on our crisis dumnmy-working
with higher and lower depreciation thresholds and periods. These alternative specifications had only a
modest impact on the parameters of interest.
9Those results are available upon request and downloadable from www.worldbank.org/lacconferences.
10 Strictly speaking, this definition would apply if under each exchange rate regime all countries possessed
the same number of time-series observations. In practice, this is not the case because our panel is
heavily unbalanced. The formula then is amended using weights given by the respective number of
observations.
7



there are any significant differences along these dimensions. In section 5, we report
country-specific estimates, for which N = 1 and hence the level parameter a is just the
regression constant.
According to conventional wisdom, more flexible exchange rate regimes should
allow countries additional room to pursue their independent monetary policy. Therefore,
the sensitivity to international interest rates should increase with the rigidity of the
exchange rate regime. In other words, for a given degree of capital mobility, real
integration, and other factors, we would expect 3fixed )Pintermediate) Ofloating  In fact, in a fixed
exchange rate regime with full capital mobility we should expect Pfixd = 1. At the
opposite extreme, if domestic monetary policy is completely independent, we would
expect Pfloating  °0. In that case, the exchange rate bears the burden of absorbing the
shocks to international interest rates. However, it is more common for countries to
pursue "dirty floating" arrangements under which they usually intervene in foreign
exchange markets, and in those cases we should find Amanaged floating)0
In turn, the country-specific effect fi measures, for each country and under each
regime, the average level of the interest rate not accounted for by foreign interest rates
and the inflation differential. Hence, it may be viewed as reflecting the mean level of
currency risk and country risk not captured by other variables. The average of the
country-specific effects under each regime (a as defined earlier) can then be viewed as a
measure of the regime's mean currency risk plus country risk. Thus, if for example more
rigidly fixed exchange rate regimes reduce devaluation expectations, for given country
risk perceptions, we should obtain afiX,d (aintermediate(afloating'
8



2.1 Data
Our basic source of interest rate data is the Intemational Financial Statistics of the
IMF. We work with monthly data on local money market rates for the 1970s, 1980s, and
1990s. We choose money market interest rates because they reflect market forces better
than deposit rates. The latter, while much more widely available, are often subject to
administrative controls and in many cases display little movement over prolonged
periods, which renders them uninformative for our purposes.'" When available, we
choose the 90-day money market rate; otherwise, we use the 30-day rate.  As
international interest rate, we use the 90-day US T-bill rate. 12  Finally, for some
experiments below, we use also the German 90-day T-bill rate.
The classification of exchange rate regimes is taken from the IMF. The Appendix
lists the regime prevailing in each country over the sample period according to this
source. The classification used here is based on a quarterly database from the IMF on
exchange rate regimes encompassing a total of 10 categories, based on officially reported
exchange arrangement for the period 1975-1996; see the Appendix for more details. We
present some empirical results (in Table 1 below) from estimating equation (1) using the
detailed regime categories in the original source. However, to facilitate our analysis, in
the rest of our experiments we condense these categories into three broader exchange rate
In a number of cases we found that the money market interest rate data from IFS were identical to the
deposit data. In such cases, we discarded countries/periods for which rates showed no variation or
infrequent step-wise movements.
12 We also experimented with the LIBOR US dollar rate. The results were very similar, since the two rates
are very highly correlated
9



regimes: fixed (pegs), intermediate (limited flexibility, crawls, bands, managed floating),
and flexible (free-floating). 13
The rest of our data-exchange rates, inflation, and country indicators, such as
population and income level on which the sample selection is based-come from the
World Bank-IMF databases.
We focus on industrial economies and middle-income developing countries.
Within this broad group, sample coverage is dictated by the availability of adequate
interest rate data.'4 The sample that results comprises 47 countries (18 industrial and 29
developing) in addition to the US, whose interest rate is used as an explanatory variable,
and a total number of monthly observations exceeding 9,400.
3. Interest Rate Sensitivity: Pooled Estimates
We first assess empirically the sensitivity of domestic interest rates to US interest
rates by estimating equation (1) using the entire sample, as well as distinguishing
between industrial and developing countries and considering subsamples defined by time
period.
Table I presents the full-sample fixed-effects estimation results, using a five-
regime classification of currency arrangements. To avoid cluttering the table, here and in
the rest of the paper we only report the coefficients of interest-i.e., the slope parameter
13 As a robustness check, we compared the results obtained with this condensed classification with those
obtained using the classification of Ghosh et al. (1996). On the whole, the results were very similar.
14 We dropped country/regime episodes possessing less than one year of consecutive monthly observations.
We also excluded countries with population under one million, countries without availability of long
exchange rate series (which automatically leads to the exclusion of Eastern European economies), low
income countries (in which the incidence of interest rate controls is more widespread), and countries
with prolonged internal or external war periods.
10



f3 and the level parameter a defined earlier-and omit the estimated coefficients on the
inflation differential and the individual country-regime fixed effects.
The top line of Table 1 shows that for the entire sample, taken as a whole, the
sensitivity of domestic to foreign rates is 0.76-and not significantly different from one
at conventional significance levels. The rest of the table shows the results obtained
estimating separate panels by exchange rate regime. Taken at face value, the pattern of
slope coefficients that emerges across regimes seems to conform to conventional
wisdom: it is highest (at 0.76) in the pegged regimes-followed by the intermediate
regimes at 0.55. Interestingly, there seems to be little difference whether the peg is to
the US dollar or to other currencies. Floating regimes show the lowest interest sensitivity
at 0.27. In fact, for the pure and managed floating regimes, the slope coefficient is
estimated imprecisely and is not significantly different from zero.
The estimated constants under each regime also deserve mention. As noted
earlier, they could be viewed as reflecting the level of the domestic interest rate
characteristic of each regime, after removing the effects of inflation and international
interest rates. The table shows that, given other things, the level of local interest rates is
lowest under fixed exchange rate arrangements.'5 At the other extreme, floating and
managed floating regimes tend to exhibit the highest interest rate levels, given other
factors.
In spite of the simplicity of our empirical specifications, they capture a fair
amount of the observed variation in interest rates, as shown by the total and within R2
15 Actually, the level estimate is lowest for pegs to currencies other than the dollar. This might reflect the
fact that during the sample period these currencies had, on average, lower interest rates than the ones
pegged to the US dollar.
11



statistics in the table. (The within R2 excludes the portion of the fit attributable to the
specific effects.)
Thus, pooling all countries and all time periods, the results seem to support the
traditional view, according to which interest rates from more flexible currency regimes
are less sensitive to foreign interest rates. We next investigate whether this result holds
when we partition the sample by income level and time period. To keep the amount of
information manageable, we proceed in the same fashion as Ghosh et al. (1999) and
condense the various exchange rate regimes into only three broader categories: fixed,
intermediate, and floating.
Table 2 divides the sample between industrial and developing countries. For the
entire sample of developing countries, the slope estimate is close to one (although not
very precise); while for industrial economies it is just above 0.62 and significantly
different from unity. As before, however, there are imnportant differences across regimes.
In both subsamples, the largest slope coefficient corresponds to the pegged regimes-
close to unity in the industrial countries, but considerably lower in the developing
countries.  In the industrial economies, the intermediate regimes exhibit the least
sensitivity to foreign interest rates. In the developing countries, no clear conclusion can
be drawn since the slope estimate under floating is highly imprecise (and negative).
Interestingly, slope estimates are uniformly lower in the developing country sample,
regardless of regime.  Rather than implying that developing countries enjoy more
monetary independence than industrial ones under any regime, the likely explanation for
this result is that, over the full 30-year sample period, developing economies were on
12



average less integrated than industrial economies into world financial markets and their
interest rates are determined less freely in the market.
Finally, the regime constants show a pattern opposite to that of the slope
estimates: for each regime, they are larger in the developing country sample than in the
industrial country sample. The difference is particularly striking in the case of floating
regimes. This suggests that, other things equal, developing countries tend to exhibit
higher interest rates than industrial countries. Across regimes, the same pattern found in
Table 1 holds for both developing and industrial countries: the constant is lowest in
pegged regimes than in the rest.
The above results are open to question, however, because the long time span of
the full sample may conceal significant variation over time in the sensitivity of domestic
to foreign interest rates, as barriers to international capital movements have declined
steadily over the last two decades. To explore this, Tables 3 and 4 further disaggregate
the samples of developing and industrial countries by decade. Table 3 presents the
results for developing countries by decade and regime. It is apparent from the table that
our slope estimates under floating regimes are very poor in all three decades of available
data-the point estimates are negative and exhibit large standard errors. Leaving floating
regimes aside, the table does suggest an upward trend in the estimated slope coefficients
across decades, both for fixed and intermediate regimes. In the 1990s, both fixed and
intermediate regimes exhibit a high degree of sensitivity to foreign interest rates, with
slope coefficients not significantly different from unity.
Table 4 presents the same information as the previous table for industrial
economies. It is important to note that the industrial country sample does not include any
13



fixed regimes after the 1970s; hence the fixed exchange rate results for the 1970s are just
those shown in Table 2 above for the entire sample period, and they reveal full
transmission of international interest rates. In the 1970s and 1980s, there is little
difference between the slope estimates of intermediate and floating regimes, with the
former slightly larger than the latter. In the 1990s, however, the result is reversed:
floating regimes show a slope estimate very close to one, while for intermediate regimes
we obtain a puzzling slope estimate, small and not different from zero.
To summarize this section, a naive look at our full-sample results would seem to
lend support to the conventional wisdom that fixed exchange rate regimes show greater
sensitivity of domestic to foreign interest rates than the other regimes. In addition, fixed
regimes also tend to exhibit lower average interest rates after other factors have been
taken into account. Using the full sample period, we also find that in general the
sensitivity of domestic interest rates to foreign rates appears higher in industrial than in
developing countries, a result suggestive of the more limited financial integration of the
latter economies over the sample period.
When looking at the results in more detail, however, the conventional wisdom
fares less well, and some puzzles emerge. First, among developing economies, both the
fixed and intermediate regimes appear to exhibit full transmission of foreign interest rates
in the 1990s. In contrast, the pooled data do not yield any sensible slope estimates for the
developing-country floating regimes. Second, among industrial countries, the floating
regimes also exhibit full transmission in the 1 990s, while intermediate regimes display an
awkward pattern, with their slope estimate declining to nearly zero in the 1990s. This
latter result is puzzling, because it appears to run counter the worldwide trend towards
14



increasing financial integration. It is worth noting that the EMU group accounts for the
bulk of countries under this regime in the 1990s, and this raises the question of whether
US interest rates-rather than, say, German interest rates-really provide the right
measure of external financial conditions for this group of countries.
In summary, there are clear discrepancies between the pooled estimates from the
full sample and those obtained from the income and period-based subsamples, In
addition, the results using pooled data may also suffer from limitations related to the
accuracy of the underlying regime classification, as well as the more general concern of
heterogeneity across countries-which the pooled estimates limit to the relatively trivial
dimension of country-specific constants. To assess the relevance of these concerns, we
next turn to country-specific estimation.
4. Interest Rate Sensitivity: Heterogeneous Estimates
To avoid possible heterogeneity biases that rnight be present in the pooled
estimates of the previous section, here we focus on individual-country estimates of
equation (1). Further, we focus on a few selected countries whose exchange rate regime
can be categorized in a relatively straightforward manner, in order to avoid the risks of
misclassification that arise when using a large number of countries. Also, we limit our
attention to the 1990s, where the puzzles mentioned above appear more evident.
Table 5 presents estimation results for 10 developing countries, grouped in the
following three regime categories. Hard pegs (currency boards) consist of Argentina and
Hong Kong. Intermediate regimes (including currency bands, managed floats, and
similar arrangements) involve Chile, Indonesia, Israel, Singapore, and Thailand. Free-
15



floating regimes comprise Mexico after the Tequila crisis, Philippines, and South
Africa. i6 In addition to the point estimates and their standard errors, the table also reports
the p-values from the test of the null hypothesis that the slope coefficient equals one (i.e.,
full sensitivity of domestic interest rates to foreign interest rates).
The first two rows of Table 5 report the estimates for the "hard pegs" of
Argentina and Hong Kong. The point estimates of the slope coefficient are close to one,
although the estimate for Argentina is rather imprecise. The next block in Table 5 reports
the results for the intermediate regimes. Here all the slope estimates are statistically
different from zero, and several of them are actually larger than one. 17 In fact, we cannot
reject the hypothesis that US interest rate changes are fully reflected in local rates for any
of the countries in the table.
The last block in the table presents the floating regimes, which yielded
implausible slope estimates in the pooled regressions of the previous section. For
Mexico, this continues to be the case in Table 5. The point estimate is large, negative and
very imprecise, a likely reflection of the financial turbulence following the Tequila crisis
that resulted in skyrocketing domestic interest rates at a time when they were declining in
the US. For the Philippines, in contrast, we fmnd a high slope coefficient, above unity.
Finally, for South Africa the slope coefficient exceeds one at standard confidence
16 In a number of instances the residuals display serial correlation; rather than differencing the data and
losing potentially valuable information, we report Newey-West standard errors robust to both
heteroskedasticity and autocorrelation. We set the number of lags for the Newey-West covariance
matrix computation at three. Results with other lag specifications were similar in most instances.
17 Whenever data permitted, we also computed country-specific estimates for an extended sample period,
which we do not report to save space. With very few exceptions, the estimates for the 1 990s reported
here were generally larger than those calculated with longer samples, suggesting an upward time trend
in the degree of interest rate transmission.
16



levels.'8 The pattern of the estimated constants across regimes is also reminiscent of that
found in the previous section: they are generally higher in the floating regimes than in the
rest.
On the whole, therefore, the developing country estimates do not show much
difference across exchange regimes regarding the sensitivity of local interest rates to
foreign ones. In most cases the estimates are consistent with the hypothesis of full
transmission of foreign interest rate disturbances, regardless of exchange regime. One
important exception is Mexico, where the estimates are too imprecise to permit any firm
conclusion. In the rest of cases, however, the data suggest that the slope coefficients are
equal to or greater than one in the 1 990s.
We now turn to the industrial countries. The pooled estimates from the previous
section revealed two surprising facts. First, intermediate regimes appeared to exhibit a
declining sensitivity to foreign interest rates, which became practically negligible in the
1990s. Second, floating regimes showed the opposite trend, with their slope coefficient
becoming equal to one in the 1 990s. We next explore these two issues in more depth.
Concerning the first puzzle, it is important to note that European countries
account for the bulk of the intermediate regimes in the 1990s.  Country-specific
estimates, which we do not report here to save space, confirm the findings from the
pooled regression, namely that the sensitivity of local rates to US T-Bill rates falls
abruptly in the 1990s. As noted earlier, however, most of these countries have in fact
belonged to the DM (now EMU) area for quite a few years, and it is unclear whether US
rates provide the right measure of "foreign interest rates" for them.
18 South Africa's multiple exchange rate regime was unified in 1995.
17



To illustrate this fact, Table 6 presents estimation results for six of these
economies using the German T-bill interest rate rather than the US T-bill rate as
explanatory variable. The results are revealing. The slope estimates are all highly
significant (with the exception of Italy in the 1990s, whose available sample is very
short). The slope coefficients actually exceed one-significantly so in all cases except
Belgium. 19 Thus, the declining pattern of the slope coefficients found in the pooled
estimates is not a reflection of increased monetary independence but, on the contrary, a
straightforward consequence of the fact that these countries have de-linked themselves
from the US dollar area to become tightly linked with the DM.
Finally, we turn to the industrial-country floating regimes. Table 7 reports
regression results for three large economies (Germany,20 Japan, and the UK) and three
smaller ones (Australia, New Zealand, and Canada). The table shows a striking contrast
between the two groups. The three smaller economies exhibit large slope coefficients
exceeding one-significantly so in Australia and New Zealand. Further, the explanatory
power of the estimated equations is fairly high. The larger economies, in turn, all possess
slope coefficients below one. For both the U.K. and Germany, the estimate for the 1990s
is insignificantly different from zero and significantly different from one. In turn, Japan
has the highest slope coefficient in this group (0.73). It is not significantly different from
one, although its precision is relatively low.2'  Again in contrast with the smaller
9 Again, if one uses longer sample periods (starting in the 1970s and 1980s), the slope coefficients turn
smaller-showing an increasing pattern over time, as the EMU area consolidated.
20 Germany obviously does not float vis-a-vis her EMU partners, but can be viewed as floating vis-a-vis the
US dollar.
21 Japan's full-sample estimate under floating (corresponding to the years 1973-99) is 0.65, numerically
similar to that obtained in the 1 990s, but its precision is much higher (a standard error of 0.09), so that
it can be safely viewed as smaller than one.
18



economies, the explanatory power of the empirical equations is quite poor for the three
large floating-regime economies.
To summarize this section, the closer inspection of individual country data
confirms some of the findings from the pooled regressions, and also helps solve some of
the puzzles they posed. On the whole, we find little evidence in the 1990s against the
hypothesis of full transmission of foreign interest rate disturbances into domestic rates,
regardless of exchange regime and income level. On the contrary, slope coefficients tend
to exceed one in several industrial and developing countries
There are exceptions, however. Most notably, large industrial countries with
floating regimes (Gernany and the UK) exhibit slope coefficients well below unity. This
suggests that large industrial countries may be the only economies that truly possess, or
make use of, monetary independence.
5. Conclusions
In this paper we have tested whether the transmission of intemational interest rate
changes to local rates is affected by the exchange rate regime. This is an important
question in the context of the debate on the choice of currency regime, in which the issue
of monetary independence has played a central role.  Proponents of free-floating
arrangements have argued that countries adopting floating regimes would be able to
pursue their own monetary policy goals, while advocates of hard pegs have questioned
the feasibility of such a strategy in a world of high international capital mobility.
The paper has taken a first step towards assessing empirically the relative merits
of these two views, by reviewing the empirical regularities on international interest rate
19



linkages for a large sample of industrial and developing countries. The approach taken
here extends and generalizes earlier studies that have focused on a small group of
countries over brief time periods. Specifically, the paper has examined the evidence from
industrial and developing countries over the last three decades, using both pooled and
single-country empirical estimates. The objective is to establish the main stylized facts
that will need to be addressed in the debate on monetary independence and the choice of
currency regime. To do this, we have employed simple reduced-form specifications
relating domestic to world interest rates. In spite of their simplicity, the empirical models
capture a large proportion of the variance in local interest rates, within and across
countries.
The main result of the paper is that over the last decade all exchange rate regimes
exhibit high sensitivity of local interest rates to international ones. Indeed, in the 1990s
we find very few instances of less-than-full transmission (i.e., a slope coefficient
significantly smaller than one), regardless of exchange rate regime. This result emerges
both from the country-specific estimates and from close inspection of the pooled
estimates.
The main exception to this rule is provided by a few large industrial countries,
which according to the evidence in the paper appear to be the only ones that can or
choose to benefit from independent monetary policy. Specifically, the slope coefficients
for Germany and the UK-large economies with floating regimes vis-a-vis the US-are
statistically smaller than one. In contrast, in other industrial countries, including smaller
economies with floating regimes (Australia, Canada, and New Zealand), local interest
20



rates fully reflect US rates. Among developing-country floating regimes, the results are
somewhat noisier.
Interestingly, during the 1990s, interest rates in European countries have become
virtually insensitive to US interest rates-but fully sensitive to German interest rates.
Thus, European countries have shifted from the US monetary area to the DM-EMU
monetary area between the 1970s and 1990s, and the decline in the responsiveness of
their interest rates to US interest rates does not signify any increase in their degree of
monetary independence.
It is important to note that the finding of complete transmission is masked in the
full-sample pooled estimates, which taken at face value would appear to support the
conventional wisdom-that fixed currency regimes tend to exhibit higher transmission
than more flexible regimes. The main reason is that the long time span of the full sample
(30 years) mixes periods characterized by very different degrees of interest rate
transmission. Indeed, the data suggest an upward time trend in the degree of sensitivity
of domestic to foreign interest rates, consistent with the gradual removal of barriers to
international capital movements and the increased financial integration of developing
economies with the rest of the world.
Finally, our pooled results suggest that interest rates are in most instances lower in
countries with fixed exchange rate regimes. The difference appears particularly large in
developing countries.
To conclude, the empirical regularities identified in the paper leave many
questions open for future research. We shall mention three. The first one concerns the
interpretation of our finding of full transmission in the 1990s, in fixed and flexible
21



regimes alike, except for large industrial economies. Does this mean that floating-regime
countries are not able to pursue their independent monetary policy, or rather that they
choose not to float, perhaps due to fear of floating?
Related to this, what is the role of financial integration in the increasing degree of
interest rate transmission shown by the data? The "Impossible Trinity" principle states
that countries can choose two of the following three: capital mobility, monetary policy,
and exchange rate flexibility. However, the fact that we found virtually full transmission
in the 1 990s seems to imply that financial integration might be playing a bigger role than
the above principle suggests.
Finally, the paper has not explored the channels through which international
interest rates are transmitted to domestic rates, nor the dynamics of the transmission
process.  -For example, to understand better the determinants of the degree of
transmission, it would be useful to explore separately the impact of international rates on
country risk premium and currency premium. This is the subject of ongoing research.
22



Appendix: Exchange Rate Regime Classification
The starting point is the IMF's quarterly database on exchange rate regimes,
which encompasses a total of 10 categories, based on officially reported exchange
arrangements for the period 1975-1996.
We transform the IMF database to a monthly basis, complementing the original
source with information contained in Cottarelli and Giannini (1997).  Finally, the
classification is extended until March 1999, using information from IMF reports and
publications, including the Exchange Rate Arrangements and Restrictions and the
International Finance Statistics, 1998 and 1999. For the countries used in the individual-
country estimates, we extend the classification until December 1999. In addition to the
original classification, we construct new categories to account for the specific currency to
which some fixed regimes are pegged.
For most experiments in the paper, we condense the ten categories in the original
source into three broader exchange rate regimes: fixed (pegs), intermediate (limited
flexibility, crawls, bands, managed floating), and flexible (free-floating). Specifically,
pegged regimes include: peg to the US dollar, peg to the French franc, peg to other
currencies (comprising Indian rupee, South African rand, British pound, and Deutsche
mark), peg to SDR (IMF basket), and basket pegs (including the so-called Bretton Woods
basket peg). In turn, intermediate regimes include: limited flexibility with respect to a
basket, limited flexibility with respect to a single currency, limited flexibility with respect
to a cooperative arrangement (including the European Monetary System), managed
floating, crawling pegs, and crawling bands. The full details are given in the Appendix
Table.
23



References
Borensztein, Eduardo and Jeromin Zettelmeyer, 2000, "Monetary Independence in
Emerging Markets: Does the Exchange Rate Make a Difference," mimeo,
International Monetary Fund.
Calvo, Guillermo and Carmen Reinhart, 2000a, "Fear of Floating," mimeo, University of
Maryland.
Calvo, Guillermo and Carmen Reinhart, 2000b, "Fixing for Your Life," Brookings Trade'
Forum, forthcoming.
Cottarelli, Carlo, and C. Giannini, 1997, "Credibility Without Rules," IMF Occasional
Paper No. 154, December.
Edwards, Sebastian and Miguel Savastano, 1999, "Exchange Rates in Emerging
Economies: What Do We Know? What Do We Need to Know?" NBER Working
Paper No. 7228, July.
Frankel, Jeffrey, 1999, "No Single Exchange Rate Regime is Right for All Countries or at
All Times," Graham Lecture, Princeton University. Essays in International
Finance No. 215, Princeton University Press: Princeton, August 1999.
Frankel, Jeffrey, Sergio Schmukler, and Luis Serven, 2000, "Verifiability and the
Vanishing Intermediate Exchange Rate Regime," Brookings Trade Forum,
forthcoming.
Ghosh, A., A. Gulde, J. Ostry, and H. Wolf, 1996, "Does The Nominal Exchange Rate
Regime Matter?" IMF Economic Issues No. 2, NBER Working Paper No. 5874
Hausmann, Ricardo, Michael Gavin, Carmen Pages-Serra, and Ernesto Stein, 1999,
"Financial Turmoil and the Choice of Exchange Rate Regime," mimeo, Inter-
American Development Bank.
Hausmann, Ricardo, Ugo Panizza, and Emesto Stein, 2000, "Why Do Countries Float the
Way they Float?" mimeo, Inter-American Development Bank.
Kaminsky, Graciela and Sergio Schmukler, "Short-Lived or Long-Lasting? A New Look
at the Effects of Capital Controls," Brookings Trade Forum, forthcoming.
24



Table 1
Local Interest Rate Responsiveness to US T-bill Rate
by Exchange Rate Regime
The table reports the constant and slope coefficients of the local interest rate (money market) on the US T-bill rate. The models are calculated by
exchange rate regime. All regressions contain country fixed effects and the inflation differential between each country and the US, which are not
reported in the table to save space. Data are from industrialized and developing countries in the 1970s, 1980s, and 1990s. Newey-West standard errors
are in parenthesis. ** and * mean that the estimate is statistically different from 0 at the 5 percent and 10 percent significance level respectively.
Constant      US T-bill    R-squared    R-squared    Number of   Number of
rate          total          within        countries   observations
Whole sample                                0.05          0.76           0.76           0.56             47           9,441
(0.00)        (0.23)
Fixed regimes                               0.04 **       0.76 **        0.76           0.31             13            517
(0.01)        (0.31)
pegged to US dollar               0.06 **        0.68 *        0.75           0.38              7             323
(0.01)        (0.40)
pegged to other currencies        0.02 **        0.64 **       0.71           0.28              8             194
(0.00)        (0.28)
Intermediate regimes                        0.08 **        0.55 **       0.84           0.39             39           6,160
(0.00)        (0.07)
band                              0.05 **        0.60 **       0.56           0.17             30            4,098
(0.00)        (0.07)
managed floating                  0.13 **        0.22          0.86           0.48             28            2,062
(0.01)        (0.19)
Free-floating regimes                      0.10 **        0.27           0.85           0.30             27           2,764
(0.01)        (0.33)



Table 2
Local Interest Rate Responsiveness to US T-bill Rate
by Income Group
The table reports the constant and slope coefficients of the local interest rate (money market) on the US T-bill rate. The models are calculated by
exchange rate regime. All regressions contain country fixed effects and the inflation differential between each country and the US, which are not reported
in the table to save space. Data are from industrialized and developing countries in the 1970s, 1980s, and 1990s. Industrialized countries are: Australia,
Austria, Belgium, Canada, Denmark, Finland, Germany, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland,
and United Kingdom. Developing countries are all the other countries listed in the Appendix Table. Newey-West standard errors are in parenthesis. **
and * mean that the estimate is statistically different from 0 at the 5 percent and 10 percent significance level respectively.
Constant    US T-bill rate  R-squared   R-squared   Number of   Number of
total         within       countries    observations
Developing countries:
Whole sample                                   0.06 **          0.93 *         0.76           0.58            29             4,279
(0.01)          (0.56)
Fixed regimes                                  0.05 **          0.63 *         0.76           0.35             7              384
(0.01)          (0.34)
Intermediate regimes                           0.11 **         0.45 **         0.85           0.43            25             2,933
(0.01)          (0.15)
Free-floating regimes                          0.24 **         -0.92           0.84           0.31             14             962
(0.02)          (I .11)
Industrialized countries:
Whole sample                                   0.04 **          0.62 **        0.47           0.22             18            5,162
(0.00)          (0.07)
Fixed regimes                                  0.00             1.03 **        0.79           0.51             6              133
(0.01)          (0.19)
Intermediate regimes                           0.05 **         0.60 **         0.44           0.20             14            3,227
(0.00)          (0.06)
Free-floating regimes                          0.03 **          0.70 **        0.53           0.26             13            1,802
(0.00)          (0.21)



Table 3
Local Interest Rate Responsiveness to US T-bill Rate
Developing Countries by Decade
The table reports the constant and slope coefficients of the local interest rate (money market) on the US T-bill rate. The models are calculated by
exchange rate regime. All regressions contain country fixed effects and the inflation differential between each country and the US, which are not
reported in the table to save space. Newey-West standard errors are in parenthesis. ** and * mean that the estimate is statistically different from 0 at
the 5 percent and 10 percent significance level respectively.
Constant       US T-bill    R-squared        R-squared    Number of   Number of
rate          total          within        countries   observations
1970s:
Fixed regimes                               0.08 **       0.05         0.94            0.01             4              191
(0.00)       (0.10)
Intermediate regimes                        0.07 **       0.51 *       0.96            0.12              5             177
(0.01)       (0.27)
Free-floating regimes                       0.22 **      -0.48         0.94            0.02             2              42
(0.06)       (0.71)
1980s:
Fixed regimes                               0.23 **       0.87 *       0.17            0.17              1             29
(0.06)       (0.49)
Intermediate regimes                        0.13 **       0.42 **      0.87            0.50             13            1,091
(0.02)       (0.18)
Free-floating regimes                       0.17 **      -0.01         0.90            0.02             4              294
(0.02)       (0.45)
990s:
Fixed regimes                               0.01          1.09 **      0.64            0.62             2              164
(0.02)       (0.25)
Intermediate regimes                        0.11 **       0.76**       0.82            0.19             22            1,665
(0.01)       (0.37)
Free-floating regimes                       0.41 **      -4.99         0.89            0.55             1 1            626
(0.04)       (4.24)



Table 4
Local Interest Rate Responsiveness to US T-bill Rate
Industrialized Countries by Decade
The table reports the constant and slope coefficients of the local interest rate (money market) on the US T-bill rate. The models are calcu4ated by
exchange rate regime. All regressions contain country fixed effects and the inflation differential between each country and the US, which are not
reported in the table to save space. Data are from industrialized and developing countries in the 1970s, 1980s, and 1990s. Newey-West
standard errors are in parenthesis. * and * mean that the estimate is statistically different from 0 at the 5 percent and 10 percent significance
level respectively.
Constant        US T-bill    R-squared    R-squared   Number of   Number of
rate           total         within        countries   observations
1970s:
Fixed regimes                            0.00             1.03 **      0.79           0.51             6              133
(0.01)         (0. I 9)
Intermediate regimes                     0.04 **         0.60 **       0.33            0.10            11             845
(0.00)          (0.13)
Free-floating regimes                    0.04 **         0.53 *        0.57            0.11             7             382
(0.01)         (0.27)
1980s:
Fixed regimes                                ..             ..           ..
Intermediate regimes                     0.06 **         0.49 **       0.72            0.27            12             1,314
(0.00)         (0. I 0)
Free-floating regimes                    0.06 **         0.38 **       0.79            0.14             7             616
(0.00)          (0. 19)
1990s:
Fixed regimes                                ..             ..           ..             ..
Intermediate regimes                     0.07 **         0.02          0.25            0.01            13             1,068
(0.00)          (0.16)
Free-floating regimes                    0.02 **         0.92 **       0.48            0.19            10             804
(0.00)         (0.29)



Table 5
Local Interest Rate Responsiveness to US T-biUl Rate
Developing Countries
The table reports the constant and slope coefficients of the local interest rate (money market) on the US T-bill rate. The coefficient for inflation is
not reported, but it is included in all regressions. Newey-West standard errors are in parenthesis. ** and * mean that the estimate is statistically
different from 0 at the S percent and 10 percent significance level respectively.
US T-bill       Test                    Number of
Sample   Constant                       slope = I  R-squared
rate                                 observations
(p-value)
Fixed regimes:
Argentina                         3/91- 12/99       0.01           1.33        0.70         0.71           106
(0.04)         (0.87)
Hong Kong                        1/94- 12/99        0.01           1.01 **    0.96         0.16            72
(0.01)         (0.16)
Intermediate regimes:
Chile                             1/90 - 8/99       0.03           1.99 **    0.21         0.49            116
(0.04)         (0.80)
Indonesia                         1/90-6/99         0.05 *         1.35 -      0.60        0.50            102
(0.03)         (0.67)
Israel                            1/90 - 12/99      0.08 **        0.94 **    0.65         0.41            120
(0.01)         (0.12)
Singapore                         1/90 - 12/99      0.00           0.86 **    0.21         0.41            120
(0.01)         (0.1 1)
Thailand                          1/90 - 3/97       0.02            1.42 **    0.15        0.44            87
(0.01)         (0.29)
Free-floating regimes:
Mexico                           12/94-12/99        0.22 *        -1.22        0.38        0.76            61
(0.12)         (2.54)
Philippines                      1/90-12/99         0.05 **        1.29 **    0.52         0.24            120
(0.02)         (0.46)
South Africa                     1/90-12/99         0.06 **        1.44 **    0.02         0.44            120
(0.01)         (0.19)



Table 6
Local Interest Rate Responsiveness to German T-bill Rate
European Industrial Countries with Intermediate Regimes
The table reports the constant and slope coefficients of the local interest rate (money market) on the German T-bill rate. The
coefficient for inflation is not reported, but it is included in all regressions. Newey-West standard errors are in parenthesis.
** and * mean that the estimate is statistically different from 0 at the 5 percent and 10 percent significance level
respectively.
German           Test                   Number of
Sample    Constant    Tbill rate           slope=1  R-squared  observations
(p-value)
Belgium            1/90 - 12/98       0.00             1.02 **   0.38         0.95           108
(0.00)           (0.02)
Denmark            1/90 - 12/99       0.00             1.25 **    0.01        0.83           120
(0.00)           (0. 10)
Italy               1/90-8/92         0.07 **          0.53        0.28       0.16            32
(0.04)           (0.43)
Netherlands        1/90 - 12/98       0.00             1.05 **   0.00         0.99           108
(0.00)           (0.02)
Portugal           1/90 - 12/99       1.82 **          1.82 **    0.00        0.85           108
(0. 10)          (0. 10)
Spain              1/90 - 12/99       0.01             1.44 **    0.00        0.83           108
(0.01)           (0.13)



Table 7
Local Interest Rate Responsiveness to US T-bill Rate
Industrial Countries with Free-Floating Regimes
The table reports the constant and slope coefficients of the local interest rate (money market) on the US T-bill rate. The
coefficient for inflation is not reported, but it is included in all regressions. Newey-West standard errors are in parenthesis. **
and * mean that the estimate is statistically different from 0 at the 5 percent and 10 percent significance level respectively.
US T-bill        Test                  Number of
Sample    Constant          rate        slope =1  R-squared  observations
(p-value)
Australia              12/90-12/99       -0.02           2.02 **    0.00        0.83           78
(0.01)        (0.17)
Canada                  1/90-12/99       -0.01           1.49 **    0.15        0.45          120
(0.02)        (0.34)
New Zealand             1/90-12/99        0.00           1.69 **    0.00        0.69           119
(0.01)        (0.18)
Germany                 1/90-12/99        0.06 **       -0.10       0.00        0.01          108
(0.02)        (0.37)
Japan                   1/90-12/99       -0.01           0.73 **   0.46         0.11           120
(0.02)        (0.37)
United Kingdom         9/92 - 12/99       0.06 **        0.05       0.00        0.03           88
(0.01)        (0.23)



Appendix Table
List of Countries in Sample and Their Exchange Rate Regimes
Country            Period       .Exchange Laelime Classification
from      to                          detailed                            reate
Argentina           Jan-80   Mar-8I                     Managed floating                    Intermediate
Apr-81   Jun-82                   Indcpendently floating                  Floating
Jul-82    Jun-89                   Managed floating                    lntermcdiatc
Jul-89    Nov-89                    Peg to US dollar                       Fixed
Dec-89   Feb-91                   Independently floating                  Floating
Mar-91   Mar-99                     Peg to US dollar                       Fixed
Australia           Oct-74   Nov-76           Limitcd flexibility with respect to a basket   Intermediatc
Dec-76   Nov-83                     Managed floating                    Intermcdiatc
Dec-83   Jun-96                   Independently floating                  Floating
Austria             Feb-70   Aug-71                 Bretton Woods basket peg                   Fixed
Sep-71   Sep-94          Limited flexibility with respect to a basket   Intermediate
Oct-94   Dec-98  Limited flexibility with respect to a cooperative arrangement   Intermediatc
Belgium             Feb-70   Dec-71                 Bretton Woods baskct peg                   Fixed
Jan-72    Jan-99   Limited flexibility with respect to a cooperative arrangement   Intermediate
Bolivia             Jan-95   Dec-97                   Independently floating                  Floating
Jan-98    Dec-98                   Managed floating                     Intcrmediate
Jan-99   Mar-99                      Crawling peg                       Intermediate
Bmzil               Mar-90   Sep-94                   Independently floating                  Floating
Oct-94   Dec-98                    Managed floating                     Intermediate
Jan-99   Mar-99                  Independently floating                   Floating
Canada              Jan-75   Mar-99                   Indcpcndendy floating                   Floating
Chile               Jan-78   May-79                   Independently floating                  Floating
Jan-80   May-82                     Peg to US dollar                       Fixed
Jun-82   Jun-82                    Managed floating                    Intermediate
Jul-82    Dec-98                Crawling pcg to a basket                Intermediate
Jan-99   Mar-99                      Crawling band                      Intcrmediate
Colombia            Mar-95   Dec-98                     Managed floating                    Intermediate
Jan-99   Mar-99                     Crawling band                      Intermediate
Costa Rica          Jan-90   Dec-91                     Managed floating                    Intermediate
Jan-92    Sep-95                 Independently floating                   Floating
Oct-95   Dec-98                    Managed floating                     Intermediate
Jan-99   Mar-99                      Crawling Pcg                       Intermediate
Denmark             Jan-72   Mar-99  Limited flexibility with rcspect to a cooperdtive arrangcmcnt   Intermediate
Dominican Rcpublic   Mar-96   Mar-99                    Managed floating                    Intermediate
Ecuador             Nov-86   Sep-94                     Managed floating                    Intermediate
Oct-94   Scp-95                 Crawling peg to a basket                Intcrmediate
Oct-95   Dec-98                    Managed floating                     Intermediate
Jan-99   Mar-99                     Crawling band                      Intermediatc
Egypt               Jan-97   Mar-99                     Managed floating                    Intermediate
El Salvador         Jan-97   Mar-99                     Managed floating                    Intermediatc
Finland             Dcc-77   Aug-92           Limited flcxibility with respect to a basket  Intermediate
Scp-92   Sep-96                  Indcpcndently floating                   Floating
Oct-96   Mar-99  Limited flcxibility with rcspect to a cooperativc arrangement   Intermcdiatc
Gcrmany             Feb-70   Apr-70                 Bretton Woods basket peg                   Fixed
May-70   Dec-71                   Independently floating                  Floating
Jan-72   Mar-73                 Bretton Woods basket peg                   Fixed
Apr-73   Mar-99  Limited flexibility with respect to a cooperative arrangement   Intermcdiate
Greece              Jan-90   Dec-94                     Managed floating                    Intermcdiatc
Jan-95   Dec-96                  Independently floating                   Floating
Jan-97    Feb-98                   Managed floating                     Intermediate
Mar-98   Mar-99  Limited flexibility with respect to a cooperative arrangcment   Intermediate
Guatemala           Jan-97   Mar-99                   Independently floating                  Floating
Hong Kong, China    Dec-90   Mar-99                     Peg to US dollar                       Fixed
Indoncsia           Jan-83    Jul-98                    Managed floating                    Intermediate
Aug-98   Jul-98                  Independcntly floating                   Floating
Ireland             Mar-72   Apr-72                 Bretton Woods basket peg                   Fixcd
Jun-72    Dcc-78                  Peg to pound sterling                    Fixed
Jan-79   Mar-99  Limited flexibility with respect to a cooperative arrangemcnt   Intermediate
Israel              Jan-90   Nov-91           Limited flexibility with rcspect to a baskct  Intermediate
Dcc-91   Dcc-98                     Managed floating                    Intermediate
Jan-99   Mar-99                      Crawling band                      Intermediatc
Italy               Jan-71    Dce-71                Brctton Woods baskct pcg                   Fixed
Jan-72   Jan-73          Limited flexibility with respect to US dollar  Intermcdiatc
Fcb-73   Dec-78                  Independently floating                   Floating
Jan-79   Aug-92  Limited flcxibility with respect to a cooperativc arrangement   Intermediatc
Sep-92   Sep-96                  Indepcndently floating                   Floating
Oct-96   Mar-99  Limited flcxibility with rcspoct to a cooperativc arrangcmcnt   Intermcdiate
Japan               Jan-70   Dec-72                 Bretton Woods basket peg                    Fixed
Jan-73    Mar-99                 Independently floating                   Floating
Korea, Rep.         Aug-76   Dcc-79                      Peg to US dollar                       Fixcd
Jan-80   Nov-97                    Managed floating                     Intermediate
Dec-97   Mar-99                   Independently floating                  Floating
Kuwait              Jan-79   Mar-99           Limited flexibility with respect to a basket  Intermediatc
Lebanon             Jan-82    Dcc-94                  Indepcndcntly floating                  Floating
Malaysia            Jan-70   Jun-72                    Peg to pound stcrling                   Fixed
Jul-72    Jun-73                    Peg to US dollar                       Fixed
Jul-73    Aug-75                 Indcpendently floating                   Floating
Scp-75   Mar-93          Limited flexibility with rcspcct to a basket   Intermediatc



Appendix Table
List of Countries in Sample and Their Exchange Rate Regimes
County          _Period                             Exchange Regime Classification
from          to                          detailed                         a Zreate
Apr-93   Aug-98                    Managed floating                     Intermediate
Sep-98   Mar-99                     Pcg to US dollar                       Fixcd
Mauritius           Jan-88    Scp-94          Limitcd flcxibility with respect to a basket  Intcrmediatc
Oct-94   Mar-99                    Managed floatine                     tntermediate
Mcxico              Apr-81   Jun-82                     Managed floating                    Intermediatc
Jul-82    Scp-82                   Peg to US dollar                       Fixed
Oct-82   Nov-94                    Managed floating                    lntcrmcdiatc
Dce-94   Mar-99                  Indepcndently floating                   Floating
Netherlands         Jan-70    Apr-70                Bretton Woods basket peg                   Fixed
May-70   Dcc-71                   Indepcndently floating                  Floating
Jan-72    Dec-98  Limitcd flcxibility with respect to a coopcrative arrangement   Intermediatc
Ncw Zealand         Mar-85   Fcb-85                     Managcd floating                    lntrnmcdiate
Mar-85   Mar-99                   Indepcndcntly floating                  Floating
Norway              Jan-72   Nov-78  Limitcd flexibility with rcspect to a coopcrative arrangcmcnt   Intermediate
Dec-78   Oct-90          Limitcd flcxibility with rcspcct to a basket   Intermcdiatc
Nov-90   Nov-92  Limited flexibility with respect to a cooperative arangement   Intcrmediate
Dec-92   Apr-94                   Independently floating                  Floating
May-94   Mar-99                     Managed floating                    Intenmcdiatc
Paraguay            Oct-90   Jun-98                   Indcpcndcntdy floating                  Floating
Philippines         Oct-81   Jun-82          Limited flexibility with respect to US dollar  Intcnemdiate
Jul-82    Sep-84                   Managed floating                    Intcrmediate
Oct-84   Mar-99                  Indepcndently floating                   Floating
Portugal            Jan-83    Scp-90                 Crawling peg to a basket               Intenmediate
Oct-90   Mar-92                    Managed floating                    Intermediate
Apr-92   Mar-99  Limitcd flexibility with respect to a cooperative arrangemcnt   Intermediate
Singapore           Aug-73   Jun-87           Limited flcxibility with respect to a baskct  Intermediatc
Jul-87    Mar-99                   Managed floating                    Intermediate
South Africa        Fcb-70   Apr-72                 Brctton Woods basket peg                   Fixed
May-72   Sep-72                   Peg to pound sterling                    Fixed
Oct-72   May-74                     Pcg to US dollar                       Fixed
Jun-74   Jun-75                    Managed floating                     Intcrmcdiate
Jul-75    Jan-79                   Pcg to US dollar                       Fixed
Feb-79   Mar-99                  Independcntly floating                   Floating
Spain               Jan-74   Jan-74                 Bretton Woods basket peg                   Fixcd
Feb-74   Dcc-75          Limited flexibility with respect to a basket  Intermcdiate
Jan-76    Dec-87                   Managed floating                     Intcrmediate
Jan-88   May-89                  Indcpcndently floating                   Floating
Jun-89   Mar-99  Limited flexibility with respect to a cooperativc arrangemcnt   Intcmcdiate
Swcden              Jan-70    Dcc-71                Brctton Woods baskct peg                   Fixcd
Jan-72    Jul-77   Limited flexibility with respect to a cooperativc arrangement   Intermediate
Aug-77   Apr-91           Limited flexibility with rcspect to a baskct  Intenmediatc
May-91   Oct-92   Limited flexibility with respect to a cooperative arrangement   Intcrmediate
Nov-92   Mar-99                   Indepcndendy floating                   Floating
Switzcrland         Sep-75    Sep-78                  Independcntly floating                  Floating
Oct-78   Dcc-79                   Pcg to Dcutschc mark                     Fixed
Jan-80   Mar-99                  Indepcndently floating                   Floating
Thailand            Jan-77    Feb-78                     Pcg to US dollar                      Fixcd
Mar-78   Jun-8 I          Limited flexibility with respect to a basket  Intermcdiatc
Jul-81    Mar-82                   Managod floating                    Intermediate
Apr-82   Oct-84          Limited flexibility with respect to US dollar  Intermediate
Nov-84   Jun-97           Limited flexibility with rcspect to a basket  Intermediate
Jul-97    Jun-98                   Managed floating                    Intermediatc
Jul-98    Mar-99                 Independently floating                  Floating
Turkcy              Apr-86   Dec-98                     Managcd floating                    Intermediate
Jan-99    Mar-99                     Crawling peg                       Intcrmediate
United Kingdom      Jul-72    Apr-72                Bretton Woods basket pcg                   Fixed
May-72   Jun-72          Limited flcxibility with respect to US dollar  Intermcdiate
Jul-72    Feb-87                 Indepcndcntly floating                  Floating
Mar-87   Feb-88                     Managed floating                    Intcnemdiate
Mar-88   Scp-90                   Independently floating                  Floating
Oct-90   Jun-92   Limited flexibility with respcct to a cooperative arangement   Intermcdiate
Jul-92    Mar-99                 Independently floating                   Floating
Uruguay             Dec-92   Dec-98                     Managed floating                    Intcrmcdiate
Jan-99   Mar-99                      Crawling band                     Intermcdiate
Vcnczuela           Apr-96   Dcc-98                     Managed floating                    Intermcdiate
Jan-99   Mar-99                      Crawling band                     Intermediatc






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