Hard or Soft Pegs? Choice of Exchange Rate Regime and Trade in Africa

This paper revisits the link between fixed exchange rate regimes and trade in the context of Africa’s exchange rate arrangements, differentiating the effects of hard pegs (currency unions) from conventional soft pegs. Using a novel dataset of exchange rate regime classification, the paper augments the gravity model of bilateral trade flows with measures of currency unions and conventional pegged arrangements, and benchmarks Africa’s experience against the rest of the world. We find that in both samples, currency unions and pegs increase trade vis-à-vis more flexible exchange rate arrangements through channels in addition to reduced exchange rate volatility; however the effect is almost twice as large for Africa. In addition, the trade-generating effect of pegs is at least as large for Africa as that of currency unions, suggesting that pegs could present a viable option—perhaps an alternative to currency unions—to promote trade in the region.