The Credibility of a Soft Pegged Exchange Rate in Emerging Market Economies: Evidence from a Panel Data Study.

We examine the credibility of the pegged exchange rate system to the US dollar in eleven emerging market economies: Bahamas, Bahrain, Barbados, Belize, Egypt, Jordan, Oman, Kuwait, Lebanon, Qatar and Venezuela, over the annual span from 1996 to 2012. The interest rate differential between the domestic economies and the base country are regressed on a set of macro-fundamentals derived from the theory and empirical work of currency crises. We construct different setups to consider the small sample size at hand and the nexus between current account and money stock as in the notion implied by the monetary approach to the balance of payments. Both unbalanced fixed effects and first difference GMM models provide evidence that inflation differential is the main driving force for generating realignment expectations, and explains why anchoring interest rates in not feasible for soft fixed exchange rate targeting countries. [ABSTRACT FROM AUTHOR]