Exchange rate regimes and current account adjustment: an empirical investigation

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 21 August 2015

Working Paper No. 544
By Fernando Eguren-Martín 

The acceleration in the formation of global imbalances in the period preceding the last financial crisis prompted a revival of the debate on whether exchange rate regimes affect the flexibility of the current account (ie its degree of mean reversion), as originally proposed by Friedman (1953). I analyse this relation systematically using a panel of 180 countries over the 1960–2007 period. In contrast to pioneering work on the subject, I find robust evidence that flexible exchange rate arrangements do deliver a faster current account adjustment among non-industrial countries. Additionally, I try to identify channels through which this effect could be taking place. Evidence suggests that exports respond to expenditure-switching behaviour by consumers when faced with changes in international relative prices. There is mixed evidence of credit acting as an additional avenue of influence.

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