Weather Shocks and Exchange Rate Flexibility
IMF Working Papers, May 13, 2022
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- Weather Shocks and Exchange Rate Flexibility
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Bibliographic details
- Authors: Selim A Elekdag, Maxwell Tuuli
- Published: May 13, 2022
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400207600.001
Research question and approach
- Research question: Does greater exchange rate flexibility help an economy’s adjustment to weather shocks?
- Method: Quantify the impact of weather shocks on real per capita GDP growth under fixed (pegged) versus flexible exchange rate regimes.
Key empirical findings
- Weather shocks are generally detrimental to per capita income growth, but the impact is less severe under flexible exchange rate regimes.
- Medium-term adverse growth impact of a 1 degree Celsius increase in temperature:
- Under a pegged regime: about –1.4 percentage points on average.
- Under a flexible regime: –0.6 percentage point.
- Exchange rate flexibility mitigates the initial impact of weather shocks and promotes a faster recovery.
Mechanisms identified
- Under flexible regimes: depreciation of the nominal exchange rate supports real export growth.
- Under pegged regimes and high public debt: countercyclical fiscal policy may not be effective, contrary to standard theoretical predictions.
- Implication: the effectiveness of stabilization depends on the policy mix and the presence of precautionary fiscal buffers.
Policy implications and recommendations
- Favor exchange rate flexibility as a tool to reduce the medium-term growth cost of temperature-related weather shocks.
- Strengthen policy coordination:
- Use exchange rate flexibility to support external adjustment and export growth after weather shocks.
- Recognize limits to countercyclical fiscal policy under pegged regimes when debt is high; prioritize precautionary (fiscal) buffers and appropriate policy mixes.
Source: Weather Shocks and Exchange Rate Flexibility, Selim A Elekdag and Maxwell Tuuli, May 13, 2022 (IMF Working Paper).
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