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Flexible Exchange Rates as Shock Absorbers

  • Sebastian Edwards
  • Eduardo Levy Yeyati

In this paper we analyze empirically the effect of terms of trade shocks on economic performance under alternative exchange rate regimes. We are particularly interested in investigating whether terms of trade disturbances have a smaller effect on growth in countries with a flexible exchange rate regime, than in countries with a more rigid exchange rate arrangement. We also analyze whether negative and positive terms of trade shocks have asymmetric effects on growth, and whether the magnitude of these asymmetries depends on the exchange rate regime. We find evidence suggesting that terms of trade shocks get amplified in countries that have more rigid exchange rate regimes. We also find evidence of an asymmetric response to terms of trade shocks: the output response is larger for negative than for positive shocks. Finally, we find evidence supporting the view that, after controlling for other factors, countries with more flexible exchange rate regimes grow faster than countries with fixed exchange rates.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9867.

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Date of creation: Jul 2003
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Publication status: published as Edwards, Sebastian and Eduardo Levy Yeyati. "Flexible Exchange Rates As Shock Absorbers," European Economic Review, 2005, v49(8,Nov), 2079-2105.
Handle: RePEc:nbr:nberwo:9867
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  1. Reinhart, Carmen & Ostry, Jonathan, 1991. "Private Saving and Terms of Trade Shocks," MPRA Paper 13716, University Library of Munich, Germany.
  2. Maurice Obstfeld & Kenneth Rogoff, 1995. "The Mirage of Fixed Exchange Rates," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 73-96, Fall.
  3. Atish R. Ghosh & Anne-Marie Gulde & Jonathan D. Ostry & Holger C. Wolf, 1997. "Does The Nominal Exchange Rate Regime Matter?," Working Papers 97-09, New York University, Leonard N. Stern School of Business, Department of Economics.
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  6. Aghion, Philippe & Howitt, Peter, 1992. "A Model of Growth Through Creative Destruction," Scholarly Articles 12490578, Harvard University Department of Economics.
  7. Eduardo Levy-Yeyati & Federico Sturzenegger, 2003. "To Float or to Fix: Evidence on the Impact of Exchange Rate Regimes on Growth," American Economic Review, American Economic Association, vol. 93(4), pages 1173-1193, September.
  8. Mendoza, Enrique G., 1997. "Terms-of-trade uncertainty and economic growth," Journal of Development Economics, Elsevier, vol. 54(2), pages 323-356, December.
  9. Robert J. Barro, 2012. "Inflation and Economic Growth," CEMA Working Papers 568, China Economics and Management Academy, Central University of Finance and Economics.
  10. Peter Kenen, 2002. "Currencies, Crises, and Crashes," Eastern Economic Journal, Eastern Economic Association, vol. 28(1), pages 1-12, Winter.
  11. Edwards, Sebastian, 1998. "Openness, Productivity and Growth: What Do We Really Know?," Economic Journal, Royal Economic Society, vol. 108(447), pages 383-98, March.
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  13. Andrew K. Rose & Eric van Wincoop, 2001. "National Money as a Barrier to International Trade: The Real Case for Currency Union," American Economic Review, American Economic Association, vol. 91(2), pages 386-390, May.
  14. Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc.
  15. Jonathan David Ostry & Carmen Reinhart, 1991. "Private Saving and Terms of Trade Shocks; Evidence From Developing Countries," IMF Working Papers 91/100, International Monetary Fund.
  16. Sebastian Edwards, 1991. "Trade Orientation, Distortions and Growth in Developing Countries," NBER Working Papers 3716, National Bureau of Economic Research, Inc.
  17. Jeffrey D. Sachs & Andrew Warner, 1995. "Economic Reform and the Process of Global Integration," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(1, 25th A), pages 1-118.
  18. Rudi Dornbusch, 2001. "Fewer Monies, Better Monies," American Economic Review, American Economic Association, vol. 91(2), pages 238-242, May.
  19. Bloomfield, Arthur I, 1984. "Effect of Growth on the Terms of Trade: Some Earlier Views," Economica, London School of Economics and Political Science, vol. 51(202), pages 187-93, May.
  20. Manuel Arellano & Stephen Bond, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Oxford University Press, vol. 58(2), pages 277-297.
  21. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
  22. William Easterly & Michael Kremer & Lant Pritchett & Lawrence H. Summers, 1993. "Good Policy or Good Luck? Country Growth Performance and Temporary Shocks," NBER Working Papers 4474, National Bureau of Economic Research, Inc.
  23. van Wincoop, Eric, 1992. "Terms of trade uncertainty, savings, and the production structure," Journal of International Economics, Elsevier, vol. 33(3-4), pages 305-325, November.
  24. Levy-Yeyati, Eduardo & Sturzenegger, Federico, 2005. "Classifying exchange rate regimes: Deeds vs. words," European Economic Review, Elsevier, vol. 49(6), pages 1603-1635, August.
  25. Paul Collier & Jan Willem Gunning, 1999. "Why Has Africa Grown Slowly?," Journal of Economic Perspectives, American Economic Association, vol. 13(3), pages 3-22, Summer.
  26. Christian Broda, 2001. "Coping with Terms-of-Trade Shocks: Pegs versus Floats," American Economic Review, American Economic Association, vol. 91(2), pages 376-380, May.
  27. Andrew M. Warner, 1992. "Did the Debt Crisis Cause the Investment Crisis?," The Quarterly Journal of Economics, Oxford University Press, vol. 107(4), pages 1161-1186.
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