Exchange Rate Regimes and External Adjustment: New Answers to an Old Debate

THE NEW INTERNATIONAL MONETARY SYSTEM: ESSAYS IN HONOR OF ALEXANDER SWOBODA, C. Wyplosz, ed., Routledge, March 2010

17 Pages Posted: 9 Dec 2011

See all articles by Atish R. Ghosh

Atish R. Ghosh

International Monetary Fund (IMF) - Policy Development and Review Department

Marco E. Terrones

International Monetary Fund (IMF)

Jeromin Zettelmeyer

Peter G. Peterson Institute for International Economics; CEPR

Date Written: October 20, 2008

Abstract

Recent research has found that current account balances under flexible regimes seem to be no less persistent than under fixed regimes. This result appears to undermine Milton Friedman’s well known — and commonly accepted — claim that flexible exchange rates facilitate the adjustment of external imbalances. Should we then dismiss Friedman’s case for flexible exchange rates as superficially plausible, but ultimately wrong? In this paper we argue that this would be premature, as the answer to the question of whether flexible regimes facilitate external adjustment appears to be sensitive to how exactly the question is asked. Are flexible exchange rate regimes associated with smaller external imbalances and more infrequent current account reversal than fixed exchange rate regimes? We find considerable evidence that large current account reversals very rarely occur under flexible regimes. Moreover, when these reversals take place they involve smaller imbalances than those reversals that take place under fixed regimes. This suggests that estimated current account persistence that does not control for these important threshold effects could be misleading.

Keywords: Flexible exchange rates, Fixed exchange rates, Current Account Balances, Current Account Reversals

JEL Classification: F31, F32, F33, F41

Suggested Citation

Ghosh, Atish R. and Terrones, Marco E. and Zettelmeyer, Jeromin, Exchange Rate Regimes and External Adjustment: New Answers to an Old Debate (October 20, 2008). THE NEW INTERNATIONAL MONETARY SYSTEM: ESSAYS IN HONOR OF ALEXANDER SWOBODA, C. Wyplosz, ed., Routledge, March 2010. Available at SSRN: https://ssrn.com/abstract=1969998

Atish R. Ghosh

International Monetary Fund (IMF) - Policy Development and Review Department ( email )

700 19th St. NW
Washington, DC 20431
United States

Marco E. Terrones (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-4329 (Phone)

HOME PAGE: http://imf.org/external/np/CV/AuthorCV.aspx?AuthID=171

Jeromin Zettelmeyer

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

CEPR ( email )

London
United Kingdom

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