Regional integration and the issue of choosing an appropriate exchange-rate regime in Latin America

Abstract Behind the discussion on optimal exchange-rate regimes lies the need to achieve external and internal equilibrium, and thus create an appropriate macroeconomic climate for sustained growth and development. The optimality and feasibility of exchange-rate regimes in individual Latin American and Caribbean countries must take into consideration several parameters linked to microeconomics, open macroeconomics, and political economy aspects. More recently, the discussion has incorporated the regional dimension and the possibility of joining monetary unions to the set of feasible national strategies. According to the optimal currency area criteria, the region still does not fit all the traditional conditions, but the empirical evidence presented in the document shows a more promising picture at subregional level. It is also argued that joining a monetary union or an exchange rate coordination mechanism could improve the policy-making process and foster better macroeconomic governance at both national and regional levels. In the authors' view, the optimal exchange-rate regime should be one that truly supports and is supported by the achievement and sustainability of sound and balanced domestic macroeconomic policies in a credible institutional framework. The present inclination in favour of non-cooperative corner solutions, either full dollarization or pure free floating implemented at purely national level, is seen as shortsighted and creates the dangerous illusion of easy solutions. Subregional cooperation offers both an intermediate option and a more coherent reference for the exchange-rate regimes in Latin America and the Caribbean. It provides the missing link for a concrete institutional building process on which macroeconomic sustainability could be founded. The paper presents a cooperative alternative to the national corner solutions of full dollarization or pure free floating. The solution is to create a set of incentives operating in a strong and institutionalised system of checks and balances at the regional level. This cooperative arrangement would bind national policy-making to a greater goal of regional macroeconomic coordination, and avoid that circumstantial problems may affect the long-term goal of good fiscal and monetary management.