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Exchange rate flexibility, the real exchange rate, and adjustment to terms‐of‐trade shocks

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  • Yan Carrière‐Swallow
  • Nicolás E. Magud
  • Juan F. Yépez

Abstract

We study the impact of exogenous terms‐of‐trade shocks in a large sample of small open economies. Using a panel vector autoregression, we estimate the response of domestic variables including the exchange rate, output, exports, imports, and domestic demand, allowing impulse responses to vary according to the de facto exchange rate regime. We find strong evidence that flexible exchange rate regimes play a shock‐absorbing role by reducing the response of output to terms‐of‐trade shocks. Results show that flexible regimes see a stronger response of the real exchange rate and faster external adjustment, suggestive of a mechanism that switches expenditure from imported to domestically‐produced goods.

Suggested Citation

  • Yan Carrière‐Swallow & Nicolás E. Magud & Juan F. Yépez, 2021. "Exchange rate flexibility, the real exchange rate, and adjustment to terms‐of‐trade shocks," Review of International Economics, Wiley Blackwell, vol. 29(2), pages 439-483, May.
    • Handle: RePEc:bla:reviec:v:29:y:2021:i:2:p:439-483
    DOI: 10.1111/roie.12534
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