October 2, 1996
|Contact:||John Williamson||(202) 328-9000|
Washington, DCA new Institute study of The Crawling Band as an Exchange Rate Regime in three important developing countries (Chile, Colombia, and Israel) demonstrates that such a system works quite well. Author John Williamson argues that other developing countries should adopt such an approach, provides a manual to guide countries that decide to do so, and notes that the success of crawling bands offers important lessons for the major industrial countries of the G-7 as well.
In recent years a number of countries have started to manage their exchange rates by publicly announcing wide bands which crawl over time so as to offset differential inflation and other developments that might otherwise make their rates diverge from the fundamentals. Three of these countriesChile, Colombia, and Israehave operated such a regime for long enough to allow an appraisal of whether it provides a workable compromise between fixed and floating exchange rates.
Williamson describes and analyzes the main problems that each of the three countries has experienced since adopting a crawling band. In Chile, the principal difficulty has been preventing strong capital inflows from making the exchange rate so strong as to undermine the model of export-led growth that underlies the country's emergence as the showpiece of Latin America. The situation in Colombia is much more difficult but Williamson argues that Colombia's exchange rate policy has been the key to its success in avoiding the sort of crisis that befell Mexico despite strong parallels in their objective situations and the occurrence of a political crisis capable of triggering economic collapse. In Israel, the principal objective of exchange rate policy has been to secure a progressive reduction in the rate of inflation without allowing the currency to become so overvalued as to threaten a crisis. While none of the countries has had a smooth ride, Williamson argues that their exchange rate regime has helped each achieve reasonable compromises between conflicting objectives. He concludes that the crawling band offers a viable exchange rate regime.
The study starts by describing the rationale and theory of a wide band, notably the way in which the existence of a published band can convert speculation into a stabilizing element, and with an enumeration of common criticisms of the crawling band. After summarizing the experiences of the three countries, and arguing that they demonstrate the validity of the regime, Williamson lays out a manual to guide other countries that might adopt a similar approach. The author makes systematic comparisons between the success of the crawling band and that of alternative exchange rate regimes; while there are too few examples of crawling bands to allow conclusions of great statistical significance, the record appears to be quite favorable.
The last chapter considers the scope for further adoption of crawling bands. Drawing on a series of brief country sketches in an appendix, Williamson argues that a number of other emerging market countries could expect to benefit by adoption of the regime. He also discusses whether the experiences of the three countries have lessons for the major industrial (G-7) countries concerning the feasibility of adopting target zones, and argues that it is a mistake to dismiss the relevance of their experiences.
The crawling bands discussed in this study are essentially the same as the target zones that have been advocated for some years by economists at the Institute, including Williamson. Since the Institute developed the idea of target zones in the mid-1980s, other economists have come to use the term to refer to any system of exchange rate bands even if they are not wide or regularly adjusted to avoid misalignments; specifically, the original ERM arrangements became known as target zones. In the hope of minimizing future confusion, we have therefore adopted the term "crawling band"Jacob Frenkel's term for a wide band that flexes in accord with publicly-explained principles designed to minimize the chance of a serious misalignment.