External Stability, Real Exchange Rate Adjustment and the Exchange Rate Regime in Emerging-Market Economies

Olivier Gervais, Lawrence Schembri () and Lena Suchanek

Discussion Papers from Bank of Canada

Abstract: In emerging-market economies, real exchange rate adjustment is critical for maintaining a sustainable current account position and thereby for helping to reduce macroeconomic and financial instability. The authors examine empirically two related hypotheses: (i) that real exchange rate flexibility and adjustment promotes external stability, and (ii) that a flexible nominal exchange rate facilitates real exchange rate adjustment. Based on an event-study analysis for a large set of emerging-market economies over the period 1975–2008, the authors find that real exchange rate adjustment has contributed significantly to reducing current account imbalances. The adjustment of current account deficits in countries with a fixed exchange rate regime does not typically occur through the classical adjustment mechanism, but as a consequence of exchange rate crises, where the nominal exchange rate collapses and there are substantial costs in terms of forgone output. Vector-error-correction results support the findings of the event study; namely, in the long run the real exchange rate movements facilitate current account adjustment.

Keywords: Development economics; Exchange rate regimes; International topics (search for similar items in EconPapers)
JEL-codes: F31 F32 F41 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2011
New Economics Papers: this item is included in nep-cba and nep-opm
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocadp:11-5

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