Pegs, Floats, and Forests: A Machine Learning Revisit of Exchange Rate Regimes and Growth in Transition Economies

TL;DR

This study uses machine learning and econometrics to analyze how exchange rate regimes affect growth in transition economies, highlighting institutional strength as a key factor.

Contribution

It combines traditional econometrics with random forest methods to validate and deepen understanding of exchange rate regime impacts on growth.

Findings

Intermediate regimes underperform fixed regimes with growth penalties of -1.0 to -10.4 percentage points.

Floating regimes show negative but largely insignificant growth differentials.

Institutional capacity influences the effectiveness of exchange rate anchoring.

Abstract

This paper combines traditional panel econometrics with random forest machine learning to revisit the relationship between exchange rate regimes and economic growth for 27 transition economies over 1991-2019. Exploiting the Couharde-Grekou (2024) probabilistic synthesis classification, the random forest approach non-parametrically confirms and sharpens what fixed-effects and system GMM estimation establish parametrically intermediate exchange rate regimes consistently underperform fixed arrangements, with growth penalties ranging from -1.0 to -10.4 percentage points, while floating regimes show negative but largely insignificant differentials. Beyond regime effects, the machine learning analysis reveals that the intermediate regime penalty is sharpest precisely where institutions are weakest - non-parametric validation that institutional capacity, not regime label alone, determines whether exchange rate anchoring pays off. The regime-growth relationship is further concentrated in the pre-2003 stabilization era and is absent among EU member economies, suggesting the growth dividend from exchange rate anchoring eroded as institutional convergence advanced. Together, these findings demonstrate how machine learning variable importance metrics can corroborate and enrich causal inference from panel methods, while supporting the view that exchange rate anchoring carried a meaningful credibility dividend during the formative phase of transition.