Commitment devices, opportunity windows, and institution building in Central Asia

Source: Lane and Milesi-Ferretti (2007) , IMF (2008). Note: No data available for Tajikistan before 1997.

Fig. 5: Financial Openness 1995 - 2006

latory frameworks, Giavazzi and Pagano (1988) have argued that fixed exchange rate rates, as
opposed to flexible ones, have a disciplining effect on the policy agenda in small open economies.
Fixed exchange rates are often a necessity in transition countries, because of the inability to
borrow in domestic currency and to hedge the exchange rate risk due to underdeveloped capital
markets, as well as the inability to conduct stability oriented monetary policy autonomously.
On the other hand, fixed exchange rates provide a target for speculative attacks. In case agents
expect undesirable policies, they are likely to speculate against the country’s currency which
may force monetary authorities to abandon the peg which is likely to trigger default of govern-
ments and firms on foreign currency loans. Thus, tying up the government’s hands by fixing
the exchange rate is likely to change priorities on the agenda in favour of reforms towards more
market-based institutions such as sound financial regulation and property rights protection in
order to prevent sudden capital outflows and speculative attacks on the exchange rate regime.

Figure 6 shows average annual exchange rate volatilities of national currencies from 1995
to 2006 against the US dollar (USD), the euro, and the German Mark (DM) prior to the
introduction of the euro. Exchange rate volatilities are calculated as Z-Scores as proposed by
Ghosh et al. (2002). For each country, the volatility measure zjt against the j-th foreign currency
at time t is calculated as Zj_t = min( μ∆e_jt + σʌ_e ,t ), whereas μδ_e and σδ_e represent the mean
and the standard deviation of the currency returns against the j-th currency (USD or euro/DM)

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