Network Effects of Countries’ Exchange Rate Regime Choices: A Spatial Analysis

This paper studies two issues of countries’ exchange rate regime (ERR) choices: why countries peg and, if they peg, how they choose their anchor currency. Previous studies focus on the use of country-specific factors to explain countries’ exchange rate regime choices. However, though some papers found strong correlation between idiosyncratic factors and ERR choices, these factors cannot fully explain the contemporary movement of the choices. It is possible that large swings in regime choices are caused by network effects: a few countries change their ERR and other countries follow. If this snowball effect is true for countries’ decisions, we should be able to observe spatial autocorrelations among countries’ ERR choices. Using spatial analysis, we found that countries are likely to follow the ERRs of other countries, and countries’ ERRs are jointly determined by network effects and country-specific factors. The findings indicate that countries may achieve higher welfare by jointly choosing their ERRs with their major partners through cooperation and negotiation.