Staff Reports
Terms of Trade and Exchange Rate Regimes in Developing Countries
March 2002 Number 148
JEL classification: E30, F31, F33, F41

Author: Christian Broda

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.

Available only in PDFPDF36 pages / 850 kb

For a published version of this report, see Christian Broda, "Terms of Trade and Exchange Rate Regimes in Developing Countries," Journal of International Economics 63, no. 1 (May 2004): 31-58.

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