Core, Periphery, Exchange Rate Regimes, and Globalization
CEPR Discussion paper : n°3077
currency mismatch, exchange rate regimes, Feldstein-Horioka tests
In this Paper we focus on the different historical regime experiences of the core and the periphery. Using conventional Feldstein-Horioka tests, but taking a more careful look at the panel properties of our sample, this Paper reports results which are consistent with the ‘Folk’ wisdom that financial integration was as high before 1914 as it is today. But the evidence suggests that it was not the exchange rate regime followed that mattered for deeper integration but the presence of capital controls. Moreover, we find that the financial integration observed for the recent period is truly an advanced country phenomenon, suggesting that the causality goes from globalization to the exchange rate regime rather than the other way round. We develop this intuition by showing that before 1914, advanced countries adhered to gold while periphery countries either emulated the advanced countries or floated. Some peripheral countries were especially vulnerable to financial crises and debt default in large part because of their extensive external debt obligations denominated in core country currencies. This left them with the difficult choice of floating but restricting external borrowing or devoting considerable resources to maintaining an extra hard peg. Today while advanced countries can successfully float, emergers, who are less financially mature and must borrow abroad in terms of advanced country currencies, are afraid to float for the same reason as their 19th century forbearers. To obtain access to foreign capital they may need a hard peg to the core country currencies, or else can resort to capital controls. Thus the key distinction between the exchange rate regime of core and periphery countries both then and now that we emphasize in this Paper is financial maturity, evidenced in the ability to issue international securities denominated in domestic currency.