Fallacy of floating? Reconsidering the ability of flexible exchange rates to offset terms-of-trade volatility in developing countries

Working paper

This paper questions the traditionally accepted superiority of flexible exchange rate regimes in o↵setting commodity price fluctuations. Employing an updated measure of the commodity terms-of-trade, a comparison of exchange rate regime classifications and more recent data than much of literature supporting this assertion, I find little evidence that flexible regimes deliver better outcomes in this regard. Although previous results are reproducible with the use of a certain terms-of-trade measure, their significance dissipates when employing an arguably more comprehensive measure. The results are similarly sensitive to the use of an alternative exchange rate regime classification. Notably, any significance found with either measure vanishes in the period after 2004, potentially indicative of a structural break in the transmission of terms-of-trade improvements to economic growth. In light of these findings, I suggest that, with updated measures and awareness of a potential structural break in hand, it may be time to re-evaluate the way in which terms-of-trade shocks have been understood to transmit in developing economies and what kind of exchange rate regime is best suited to this transmission mechanism.

Authors: Popescu, IO

• Publication status: Published
• Publisher: Centre for the Study of African Economies
• Series: CSAE Working Papers
• Publication date: 2023-04-13
• Paper number: 2023-01
• Language: English