IDEAS home Printed from
MyIDEAS: Log in (now much improved!) to save this paper

Does higher openness cause more real exchange rate volatility ?

  • Calderon, Cesar
  • Kubota, Megumi

The"New Open Economy Macroeconomics"argues that: (a) non-monetary factors have gained importance in explaining exchange rate volatility, and (b) trade and financial openness may have a potential role of mitigating and/or amplifying real and nominal shocks to real exchange rates. The goal of the present paper is to examine the ability of trade and financial openness to exacerbate or mitigate real exchange rate volatility. The authors collected information on the real effective exchange rate, its fundamentals, and (outcome and policy measures of) trade and financial openness for a sample of industrial and developing countries for the period 1975-2005. Using instrumental variables techniques, the analysis finds that: (a) High real exchange rate volatility is the result of highly volatile productivity shocks, and sharp oscillations in monetary and fiscal policy shocks. (b) Countries more integrated with international markets of goods and services tend to display more stable real exchange rate fluctuations. (c) Financial openness seems to amplify the fluctuations in real exchange rates. (d) The composition of trade and capital flows plays a role in explaining the smoothing properties of trade and financial openness. Although the former is mainly driven by manufacturing trade, the latter depends on the share of debt (and equity) in total foreign liabilities. (e) Financial openness would attenuate (magnify) real exchange rate volatility, the greater the share of equity (debt) in foreign liabilities. (f) The composition of flows also matters for explaining the smoothing properties of trade and financial openness in periods of currency crisis.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: no

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 4896.

in new window

Date of creation: 01 Apr 2009
Date of revision:
Handle: RePEc:wbk:wbrwps:4896
Contact details of provider: Postal:
1818 H Street, N.W., Washington, DC 20433

Phone: (202) 477-1234
Web page:

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Romain Wacziarg & Karen Horn Welch, 2008. "Trade Liberalization and Growth: New Evidence," World Bank Economic Review, World Bank Group, vol. 22(2), pages 187-231, June.
  2. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  3. Luca Dedola & Sylvain Leduc, 2001. "Why is the Business-Cycle Behavior of Fundamentals Alike Across Exchange-Rate Regimes?," Temi di discussione (Economic working papers) 411, Bank of Italy, Economic Research and International Relations Area.
  4. Jeffrey A. Frankel & Eduardo A. Cavallo, 2004. "Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, Or Less? Using Gravity to Establish Causality," NBER Working Papers 10957, National Bureau of Economic Research, Inc.
  5. André Faria & Philip R. Lane & Paolo Mauro & Gian Maria Milesi-Ferretti, 2007. "The Shifting Composition of External Liabilities," The Institute for International Integration Studies Discussion Paper Series iiisdp190, IIIS.
  6. Hau, Harald, 2000. "Exchange rate determination: The role of factor price rigidities and nontradeables," Journal of International Economics, Elsevier, vol. 50(2), pages 421-447, April.
  7. Stockman, Alan C. & Stockman, Alan C., 1983. "Real exchange rates under alternative nominal exchange-rate systems," Journal of International Money and Finance, Elsevier, vol. 2(2), pages 147-166, August.
  8. Devereux, Michael B. & Lane, Philip R., 2003. "Understanding bilateral exchange rate volatility," Journal of International Economics, Elsevier, vol. 60(1), pages 109-132, May.
  9. 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.
  10. Hausmann, Ricardo & Panizza, Ugo & Rigobon, Roberto, 2006. "The long-run volatility puzzle of the real exchange rate," Journal of International Money and Finance, Elsevier, vol. 25(1), pages 93-124, February.
  11. Barbara Annicchiarico, 2003. "Fiscal Policy and Exchange Rates," CEIS Research Paper 7, Tor Vergata University, CEIS.
  12. Atish R. Ghosh & Anne-Marie Gulde & Holger C. Wolf, 2003. "Exchange Rate Regimes: Choices and Consequences," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262072408, December.
  13. Caselli, Paola, 2001. "Fiscal consolidation under fixed exchange rates," European Economic Review, Elsevier, vol. 45(3), pages 425-450, March.
  14. Stockman, A.C., 1988. "Real Exchange Rate Variability Under Pegged And Floating Nominal Exchange Rate Systems: An Equilibrium Theory," RCER Working Papers 128, University of Rochester - Center for Economic Research (RCER).
  15. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  16. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," The Quarterly Journal of Economics, Oxford University Press, vol. 119(1), pages 1-48.
  17. Philippe Aghion & Philippe Bacchetta & Romain Ranciere & Kenneth Rogoff, 2006. "Exchange Rate Volatility and Productivity Growth: The Role of Financial Development," NBER Working Papers 12117, National Bureau of Economic Research, Inc.
  18. Robert Summers & Alan Heston, 1991. "The Penn World Table (Mark 5): An Expanded Set of International Comparisons, 1950–1988," The Quarterly Journal of Economics, Oxford University Press, vol. 106(2), pages 327-368.
  19. Luca Dedola & Sylvain Leduc, 2002. "Why are business cycles alike across exchange-rate regimes?," Working Papers 02-11, Federal Reserve Bank of Philadelphia.
  20. Strotmann, Harald & Döpke, Jörg & Buch, Claudia M., 2006. "Does trade openness increase firm-level volatility?," Discussion Paper Series 1: Economic Studies 2006,40, Deutsche Bundesbank, Research Centre.
  21. Mody, Ashoka & Murshid, Antu Panini, 2005. "Growing up with capital flows," Journal of International Economics, Elsevier, vol. 65(1), pages 249-266, January.
  22. Maurice Obstfeld and Kenneth Rogoff., 1995. "Exchange Rate Dynamics Redux," Center for International and Development Economics Research (CIDER) Working Papers C95-048, University of California at Berkeley.
  23. Bleaney, Michael & Greenaway, David, 2001. "The impact of terms of trade and real exchange rate volatility on investment and growth in sub-Saharan Africa," Journal of Development Economics, Elsevier, vol. 65(2), pages 491-500, August.
  24. Broda, Christian, 2004. "Terms of trade and exchange rate regimes in developing countries," Journal of International Economics, Elsevier, vol. 63(1), pages 31-58, May.
  25. Philip Lane & Gian Maria Milesi-Ferretti, 2001. "THE EXTERNAL WEALTH OF NATIONS: Measures of Foreign Assets and Liabilities For Industrial and Developing Countries," Trinity Economics Papers 20014, Trinity College Dublin, Department of Economics.
  26. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  27. Norman Loayza & Pablo Fajnzylber & César Calderón, 2004. "Economic Growth in Latin America and The Caribbean: Stylized Facts, Explanations, and Forecasts," Working Papers Central Bank of Chile 265, Central Bank of Chile.
  28. James R. Lothian & Cornelia McCarthy, 2001. "Real Exchange-Rate Behaviour under Fixed and Floating Exchange Rate Regimes," International Finance 0107002, EconWPA.
  29. Sebastian Edwards & Eduardo Levy Yeyati, 2004. "Flexible Exchange Rates as Shock Absorbers," Business School Working Papers exchangerates, Universidad Torcuato Di Tella.
  30. M Arellano & O Bover, 1990. "Another Look at the Instrumental Variable Estimation of Error-Components Models," CEP Discussion Papers dp0007, Centre for Economic Performance, LSE.
  31. Paolo Mauro & Andre Faria, 2004. "Institutions and the External Capital Structure of Countries," IMF Working Papers 04/236, International Monetary Fund.
  32. Gian M Milesi-Ferretti & Assaf Razin, 1998. "Current Account Reversals and Currency Crises; Empirical Regularities," IMF Working Papers 98/89, International Monetary Fund.
  33. Sercu,Piet & Uppal,Raman, 2006. "Exchange Rate Volatility, Trade, and Capital Flows under Alternative Exchange Rate Regimes," Cambridge Books, Cambridge University Press, number 9780521034234, November.
  34. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
  35. Julian di Giovanni & Andrei A. Levchenko, 2006. "Trade Openness and Volatility," Development Working Papers 219, Centro Studi Luca d'Agliano, University of Milano.
  36. Marianne Baxter & Michael A. Kouparitsas, 2000. "What Can Account for Fluctuations in the Terms of Trade?," Boston University - Department of Economics - The Institute for Economic Development Working Papers Series dp-112, Boston University - Department of Economics.
  37. Alonso-Borrego, Cesar & Arellano, Manuel, 1999. "Symmetrically Normalized Instrumental-Variable Estimation Using Panel Data," Journal of Business & Economic Statistics, American Statistical Association, vol. 17(1), pages 36-49, January.
  38. Hau, Harald, 2002. "Real Exchange Rate Volatility and Economic Openness: Theory and Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(3), pages 611-30, August.
  39. Paolo Mauro & Andrei A Levchenko, 2006. "Do Some Forms of Financial Flows Help Protect From Sudden Stops?," IMF Working Papers 06/202, International Monetary Fund.
  40. Baxter, Marianne & Stockman, Alan C., 1989. "Business cycles and the exchange-rate regime : Some international evidence," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 377-400, May.
  41. Christian Broda & John Romalis, 2011. "Identifying the Relationship Between Trade and Exchange Rate Volatility," NBER Chapters, in: Commodity Prices and Markets, East Asia Seminar on Economics, Volume 20, pages 79-110 National Bureau of Economic Research, Inc.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:wbk:wbrwps:4896. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Roula I. Yazigi)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.