Terms of trade and exchange rate regimes in developing countries

Christian Broda

No 148, Staff Reports from Federal Reserve Bank of New York

Abstract: Since Friedman (1953), an advantage often attributed to flexible exchange rate regimes over fixed regimes is their ability to insulate more effectively the economy against real shocks. I use a post-Bretton Woods sample (1973-96) of seventy-five developing countries to assess whether the responses of real GDP, real exchange rates, and prices to terms-of-trade shocks differ systematically across exchange rate regimes. I find that responses are significantly different across regimes in a way that supports Friedman's hypothesis. In response to a negative terms-of-trade shock, countries with fixed regimes experience large and significant declines in real GDP, and the real exchange rate depreciates slowly and by means of a fall in prices. Countries with more flexible regimes, by contrast, tend to have small real GDP losses and immediate large real depreciations. The contributions of terms-of-trade disturbances to the actual fluctuation of real GDP, real exchange rates, and prices are also examined.

Keywords: Foreign exchange rates; Foreign exchange (search for similar items in EconPapers)
Date: 2002
New Economics Papers: this item is included in nep-ifn and nep-mac
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Citations: View citations in EconPapers (8)

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