Reasons for Divergences Between De facto and De jure Policies

The first reason for the divergences between de facto and de jure exchange rate policies is that, de facto exchange rate stability is just an incidental side effect of a monetary policy strategy in which the exchange rate is only one of the many variables that the central bank monitors and reacts to. This is as; whatever decision of the authorities of the country that is being made in turn will have an effect on the pricing of its goods and services, economic wellbeing of the country and also its exchange rate. The second reason to it is that, the central bank thinks that the economy will occasionally be affected by idiosyncratic shocks that will require significant exchange rate adjustments. This means that the central bank does not want the exchange rate to be tied by a previous commitment that might make the adjustments more difficult to be carried out. The third reason to why the divergences between the de facto and de jure policies are that a country is afraid to being a focus of attention to speculators if they were to announce parity for the exchange rate. They fear that the currency would have a higher probability of being attacked by speculators through buying and selling of the domestic currency in the international financial market and making it unstable.

The best reason out of the three to the plausible reasons for divergences between de facto and de jure policies is the third reason where a country is afraid to announce parity on their exchange rate in fear to the behaviour of speculators. As according to the empirical test that is found in the article written by Genberg and Swoboda(2005), this particular hypothesis is consistent with the findings. The test used the Reinhart–Rogoff database to extract the countries and months that fell into the de facto fixed exchanged rate classification. They also used the IMF de jure classifications as reported in Ghosh,Gulde and Wolf(2002) to divide the de facto fixers and de jure fixers and de jure floaters. With the data collected the monthly percentage change in the market exchange rate is being calculated. From the test, the following result is found and that the de facto fix and de jure fix category contains a higher frequency of large exchange rate changes compared to the de facto fix and de jure float category. Therefore, there is consistency with the hypothesis that the reason some de facto fixers do not want to announce a fixed exchange rate is that they fear that doing so would lead to speculative attacks resulting in occasionally large devaluations and revaluations of their domestic currency. Thus, making the targeted exchange rate unstable and deteriorates the economic wellbeing of a country.

Source: Scribd.com

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