De jure and De facto Exchange Rate Regimes

de jure exchange rate regimes

The de jure exchange rate regimes can be defined as what a countries government ‘claims’ to do and in regard with the bipolar view, supports it and shows that countries are generally moving towards either corner of the bipolar view of fixed exchange rate or floating exchange rate. The de jure exchange rate regimes are important as a way of what the central bank communicates to the public as this is likely to have bearing on the outcome. By having a de jure fixed exchange rate and a de facto floating exchange rate, the breach of commitment will likely have negative consequences. On the other hand, having a de jure floating exchange rate and a de facto fixed exchange rate does not breach its commitments.

de facto exchange rate regimes

The de facto exchange rate regime can be defined as what a countries government actually does in regard to its exchange rate system despite what it claims. This is usually associated with a ‘fear of floating’ and is usually seen as intermediate exchange rate regimes. The bipolar view is not really supported as country’s actual (de facto) exchange rate regime often differs from its de jure, or officially announced, policy, raising questions about whether the observed trend away from intermediate regimes is a fallacy. The crux of the matter can be briefly put: free capital movements can be hugely beneficial if they are well-behaved but in the real world they can be perverse. There is therefore a case for government action to counter this perversity. This view does not however support the bipolar view which claims that the market would find its own way around them.


Bipolar View of Exchange Rate Policy

The bipolar view predicts that all countries will move to the “fixed” and “floating” corners of the spectrum of exchange rate regimes.

From one point of view of the bipolar view is the fixed exchange rate. The term fixed exchange rate is defined as one which is irrevocably fixed, i.e. a super-hard peg. In this regime, the central bank commits itself irrevocably to defending a fixed exchange rate. The strength of this regime is that it provides a firm anchor against inflation, provided of course that the peg-currency is stable in value. The outstanding weakness of this regime follows from the complete surrender of monetary sovereignty that it entails.

The second stand point of the bipolar view is the floating exchanged rate. The term can be defined as a regime in which the authorities do not have an exchange rate target, formal or informal. The strength of this regime is that it facilitates real adjustment. Exchange rate movements provide a natural cushion against real shocks. Floating exchange rates however are prone to inflation unless supported by a firm domestic nominal anchor. The exchange rates are also prone to fluctuations and are not suitable for small developing countries where traded goods are a big part of output (motivating the formation of the EMU).