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Exchange rate flexibility, the real exchange rate, and adjustment to terms‐of‐trade shocks
Author(s) -
CarrièreSwallow Yan,
Magud Nicolás E.,
Yépez Juan F.
Publication year - 2021
Publication title -
review of international economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.513
H-Index - 58
eISSN - 1467-9396
pISSN - 0965-7576
DOI - 10.1111/roie.12534
Subject(s) - economics , exchange rate , exchange rate flexibility , monetary economics , shock (circulatory) , impulse response , vector autoregression , exchange rate regime , terms of trade , effective exchange rate , sample (material) , cointegration , econometrics , flexibility (engineering) , international economics , macroeconomics , medicine , mathematical analysis , chemistry , mathematics , management , chromatography
We study the impact of exogenous terms‐of‐trade shocks in a large sample of small open economies. Using a panel vector autoregression, we estimate the response of domestic variables including the exchange rate, output, exports, imports, and domestic demand, allowing impulse responses to vary according to the de facto exchange rate regime. We find strong evidence that flexible exchange rate regimes play a shock‐absorbing role by reducing the response of output to terms‐of‐trade shocks. Results show that flexible regimes see a stronger response of the real exchange rate and faster external adjustment, suggestive of a mechanism that switches expenditure from imported to domestically‐produced goods.