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Terms of trade and exchange rate regimes in developing countries

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  • Christian Broda
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    Abstract

    Since Friedman (1953), an advantage often attributed to flexible exchange rate regimes over fixed regimes is their ability to insulate more effectively the economy against real shocks. I use a post-Bretton Woods sample (1973-96) of seventy-five developing countries to assess whether the responses of real GDP, real exchange rates, and prices to terms-of-trade shocks differ systematically across exchange rate regimes. I find that responses are significantly different across regimes in a way that supports Friedman's hypothesis. In response to a negative terms-of-trade shock, countries with fixed regimes experience large and significant declines in real GDP, and the real exchange rate depreciates slowly and by means of a fall in prices. Countries with more flexible regimes, by contrast, tend to have small real GDP losses and immediate large real depreciations. The contributions of terms-of-trade disturbances to the actual fluctuation of real GDP, real exchange rates, and prices are also examined.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 148.

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    Date of creation: 2002
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    Handle: RePEc:fip:fednsr:148

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    Keywords: Foreign exchange rates ; Foreign exchange;

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    Cited by:
    1. Quader, Syed Manzur, 2004. "Floating Exchange Rate Regime," MPRA Paper 26163, University Library of Munich, Germany.
    2. Jeannine Bailliu & Robert Lafrance & Jean-François Perrault, 2002. "Does Exchange Rate Policy Matter for Growth?," Working Papers 02-17, Bank of Canada.
    3. Dungey, Mardi, 2004. "Identifying terms of trade effects in real exchange rate movements: evidence from Asia," Journal of Asian Economics, Elsevier, vol. 15(2), pages 217-235, April.

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