Flexibility: Stability's Best Friend in Non-transparent Countries?

This paper proposes a framework for studying the optimal exchange rate regime in an open economy vulnerable to self-fulfilling currency crises. Model results show that the optimal regime a country's government should adopt critically depends on the country's level of transparency. Furthermore, stabilisation properties are conditional on conjectural and time-varying factors such as market sentiments, which swing according to international investors’ feelings. Thus, and paradoxically, in a weakly transparent economy, greater flexibility gives rise to a wide range of exchange-rate stability compared with hard-anchoring regimes. Key to this is the role of expectations coordination during stressful scenarios.