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Friedman Redux: External Adjustment and Exchange Rate Flexibility

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  • Mr. Atish R. Ghosh
  • Mahvash S Qureshi
  • Mr. Charalambos G Tsangarides

Abstract

Milton Friedman argued that flexible exchange rates would facilitate external adjustment. Recent studies find surprisingly little robust evidence that they do. We argue that this is because they use composite (or aggregate) exchange rate regime classifications, which often mask very heterogeneous bilateral relationships between countries. Constructing a novel dataset of bilateral exchange rate regimes that differentiates by the degree of exchange rate flexibility, as well as by direct and indirect exchange rate relationships, for 181 countries over 1980–2011, we find a significant and empirically robust relationship between exchange rate flexibility and the speed of external adjustment. Our results are supported by several “natural experiments” of exogenous changes in bilateral exchange rate regimes.

Suggested Citation

  • Mr. Atish R. Ghosh & Mahvash S Qureshi & Mr. Charalambos G Tsangarides, 2014. "Friedman Redux: External Adjustment and Exchange Rate Flexibility," IMF Working Papers 2014/146, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2014/146
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    Cited by:

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    2. Paredes, Gonzalo J., 2017. "Ecuador: why exit dollarization?," Revista CEPAL, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), April.
    3. Mr. Manuk Ghazanchyan & Ms. Janet Gale Stotsky & Qianqian Zhang, 2015. "A New Look at the Determinants of Growth in Asian Countries," IMF Working Papers 2015/195, International Monetary Fund.
    4. 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.
    5. Yang, Haizhen & Zhang, Mengting & Xiang, Yue & Yang, Yang, 2023. "The balance of payments stages hypothesis: Improvements and new discoveries," International Review of Economics & Finance, Elsevier, vol. 84(C), pages 635-656.
    6. Cécile Couharde & Carl Grekou, 2016. "Currency Misalignments in emerging and developing countries: reassessing the role of Exchange Rate Regimes," Post-Print hal-01549901, HAL.
    7. Carl Grekou, 2016. "Does the exchange rate regime shape currency misalignments in emerging and developing countries?," Working Papers hal-04141583, HAL.
    8. Carl Grekou, 2016. "Does the exchange rate regime shape currency misalignments in emerging and developing countries?," EconomiX Working Papers 2016-26, University of Paris Nanterre, EconomiX.
    9. Dausà, Neus & Stracca, Livio, 2023. "The asymmetric adjustment of global imbalances: myth or fact?," Working Paper Series 2777, European Central Bank.
    10. Alberto Fuertes, 2019. "Exchange rate regime and external adjustment: An empirical investigation for the US," The World Economy, Wiley Blackwell, vol. 42(5), pages 1373-1399, May.
    11. Albagli, Elias & Calani, Mauricio & Hadzi-Vaskov, Metodij & Marcel, Mario & Ricci, Luca Antonio, 2020. "Comfort in Floating: Taking Stock of Twenty Years of Freely-Floating Exchange Rate in Chile," CEPR Discussion Papers 14967, C.E.P.R. Discussion Papers.
    12. Balvers, Ronald J. & McDonald, Bill, 2021. "Designing a global digital currency," Journal of International Money and Finance, Elsevier, vol. 111(C).
    13. Eguren Martin, Fernando, 2016. "Exchange rate regimes and current account adjustment: An empirical investigation," Journal of International Money and Finance, Elsevier, vol. 65(C), pages 69-93.
    14. Pablo Duarte & Gunther Schnabl, 2015. "Macroeconomic Policy Making, Exchange Rate Adjustment and Current Account Imbalances in Emerging Markets," Review of Development Economics, Wiley Blackwell, vol. 19(3), pages 531-544, August.
    15. Alberto Fuertes, 2019. "External adjustment with a common currency: the case of the euro area," Working Papers 1936, Banco de España.
    16. Cécile Couharde & Carl Grekou, 2021. "Better Two Eyes than One: A Synthesis Classification of Exchange Rate Regimes," Working Papers 2021-07, CEPII research center.
    17. Aizenman, Joshua, 2019. "A modern reincarnation of Mundell-Fleming's trilemma," Economic Modelling, Elsevier, vol. 81(C), pages 444-454.

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