A Faith-Based Initiative: Does a Flexible Exchange Rate Regime Really Facilitate Current Account Adjustment?

Abstract

This working paper was written by Menzie D. Chinn (University of Wisconsin, Madison and National Bureau of Economic Research ) and Shang-Jin Wei (Columbia University and National Bureau of Economic Research).

The assertion that a flexible exchange rate regime would facilitate current account adjustment is often repeated in policy circles. In this paper, we compile a data set encompassing data for over 170 countries over the 1971-2005 period, and examine whether the rate of current account reversion depends upon the de facto degree of exchange rate fixity, as measured by two popular indices. We find that there is no strong, robust, or monotonic relationship between exchange rate regime flexibility and the rate of current account reversion, even after accounting for the degree of economic development, the degree of trade and capital account openness. We also find that the endogenous selection of exchange rate regimes does not explain the observed lack of correlation.

Keywords: Floating Exchange Rate, Fixed Exchange Rate, Current Account Imbalances, Real Exchange Rates

JEL Classification: F3