Friedman Redux: External Adjustment and Exchange Rate Flexibility

Author/Editor: Atish R. Ghosh ; Mahvash Saeed Qureshi ; Charalambos G. Tsangarides
Publication Date: August 08, 2014
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate
Summary: Milton Friedman argued that flexible exchange rates would facilitate external adjustment. Recent studies find surprisingly little robust evidence that they do. We argue that this is because they use composite (or aggregate) exchange rate regime classifications, which often mask very heterogeneous bilateral relationships between countries. Constructing a novel dataset of bilateral exchange rate regimes that differentiates by the degree of exchange rate flexibility, as well as by direct and indirect exchange rate relationships, for 181 countries over 1980–2011, we find a significant and empirically robust relationship between exchange rate flexibility and the speed of external adjustment. Our results are supported by several “natural experiments” of exogenous changes in bilateral exchange rate regimes.
Series: Working Paper No. 14/146
Subject(s): Flexible exchange rates | Exchange rate adjustments | Exchange rate regimes | Balance of trade | Current account balances

Publication Date: August 08, 2014
ISBN/ISSN: 9781498359245/1018-5941 Format: Paper
Stock No: WPIEA2014146 Pages: 43
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