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Fixed Exchange Rates and Trade

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  • Michael W. Klein
  • Jay C. Shambaugh

Abstract

A classic argument for a fixed exchange rate is its promotion of trade. Empirical support for this, however, is mixed. While one branch of research consistently shows a small negative effect of exchange rate volatility on trade, another, more recent, branch presents evidence of a large positive impact of currency unions on trade. This paper helps resolve this disconnect. Our results, which use a new data-based classification of fixed exchange rate regimes, show a large, significant effect of a fixed exchange rate on bilateral trade between a base country and a country that pegs to it. Furthermore, the web of fixed exchange rates created when countries link to a common base also promotes trade, but only when these countries are part of a wider system, as during the Bretton Woods period. These results suggest an economically relevant role for exchange rate regimes in trade determination since a significant amount of world trade is conducted between countries with fixed exchange rates.

Suggested Citation

  • Michael W. Klein & Jay C. Shambaugh, 2004. "Fixed Exchange Rates and Trade," NBER Working Papers 10696, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:10696
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