Weather Shocks and Exchange Rate Flexibility

Selim Elekdag and Maxwell Tuuli

No 2022/093, IMF Working Papers from International Monetary Fund

Abstract: This paper assesses the stabilization properties of fixed versus flexible exchange rate regimes and aims to answer this research question: Does greater exchange rate flexibility help an economy’s adjustment to weather shocks? To address this question, the impact of weather shocks on real per capita GDP growth is quantified under the two alternative exchange rate regimes. We find that although weather shocks are generally detrimental to per capita income growth, the impact is less severe under flexible exchange rate regimes. Moreover, the medium-term adverse growth impact of a 1 degree Celsius increase in temperature under a pegged regime is about –1.4 percentage points on average, while under a flexible regime, the impact is less than one half that amount (–0.6 percentage point). This finding bolsters the idea that exchange rate flexibility not only helps mitigate the initial impact of the shock but also promotes a faster recovery. In terms of mechanisms, our findings suggest that the depreciation of the nominal exchange rate under a flexible regime supports real export growth. In contrast to standard theoretical predictions, we find that countercyclical fiscal policy may not be effective under pegged regimes amid high debt, highlighting the importance of the policy mix and precautionary (fiscal) buffers.

Keywords: Exchange rate regimes; Economic growth; Climate change; weather shock; growth impact; regime s; decline in government expenditure growth; peg exchange rate regime; temperature shock; government consumption growth; regime window; Exchange rate arrangements; Exchange rate flexibility; Conventional peg; Exchange rate adjustments; Emerging and frontier financial markets; Global (search for similar items in EconPapers)
Pages: 38
Date: 2022-05-13
New Economics Papers: this item is included in nep-env and nep-opm
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