Exchange Rates and External Adjustment

Milton Friedman argued that flexible exchange rates facilitate external adjustment. Recent studies find surprisingly little robust evidence that they do. We argue that this is because they use composite (‘multilateral’) exchange rate regime classifications, which often mask heterogeneous bilateral relationships between countries. Constructing a novel bilateral exchange rate regimes data set for 181 countries over 1980–2011, we find a statistically strong relationship between exchange rate flexibility and the speed of external adjustment. Our results are supported by several ‘natural experiments’ of exogenous changes in bilateral exchange rate regimes, and by Monte Carlo simulations, which show that tests based on standard multilateral regime classifications tend to have low statistical power.

The period preceding the global financial crisis was characterized by a substantial widening of current account imbalances across the world. Since the onset of the crisis, these imbalances have contracted to a significant extent. In this paper, we analyze the ongoing process of external adjustment in advanced economies and emerging markets. We find that countries whose pre-crisis current account balances were in excess of what could be explained by standard economic fundamentals have experienced the largest contractions in their external balance. We subsequently examine the contributions of real exchange rates, domestic demand and domestic output to the adjustment process (allowing for differences across exchange rate regimes) and find that external adjustment in deficit countries was achieved primarily through demand compression, rather than expenditure switching. Finally, we show that changes in other investment flows were the main channel of financial account adjustment, with official external assistance and ECB liquidity cushioning the exit of private capital flows for some countries.

Revisiting Japan's External Adjustment Since 1985

After the decline in oil prices, many oil exporters face the need to improve their external balances. Special characteristics of oil exporters make the exchange rate an ineffective instrument for this purpose and give fiscal policy a sizeable role. These conclusions are supported by regression analysis of the determinants of the current account balance and of the trade balance. The results show little or no relationship with the exchange rate and, especially for the less diversified oil exporters, a strong relationship with the fiscal balance or government spending.

The member countries of the IMF collaborate to try to ensure orderly exchange arrangements and promote a stable system of exchange rates, recognizing that the essential purpose of the international monetary system is to facilitate the exchange of goods, services, and capital, and to sustain sound economic growth. The paper reviews the stability of the overall system of exchange rates by examining macroeconomic performance (inflation, growth, crises) under alternative exchange rate regimes; implications of exchange rate regime choice for interaction with the rest of the system (external adjustment, trade integration, capital flows); and potential sources of stress to the international monetary system.

External Adjustment in Oil Exporters: The Role of Fiscal Policy and the Exchange Rate

A Opening Addresses.- I Introduction.- II The Role of Financial Markets in the Adjustment Process: the Finnish Experience.- III The International Adjustment Process.- IV Problems of Adjustment in Developing Countries.- B Current and Potential Balance of Payments Adjustment Problems.- V External Adjustment in Small Open Economies - Some Recent Experience.- VI Balance of Payments Adjustment Processes in Japan.- VII US External Adjustment in Response to the Lower Dollar: the J-Curve.- VIII Balance of Payments Adjustment Problems - the Case of West Germany.- C The Modus Operandi of The Process of Adjustment.- IX Current and Prospective Balance of Payments Problems.- X Policy Design in the Face of a Terms of Trade Shock.- XI Financial Interdependence and External Adjustment: Some Problems Posed by US Federal Government Indebtedness.- XII Mode Operatoire D'ajustement et Marches Speculatifs - Premiers Enseignements de la Crise Financiere Recente.- D Adjustment Policies.- XIII Exchange Rate Target Zones, the Louvre Accord and Policy Coordination.- XIV Reflections on World Economic Imbalances.- XV The International Economic Adjustment Mechanisms and the Coordination of Economic Policies.- XVI Recent Experience of International Monetary Policy Cooperation.- XVII The International Monetary System: Recent Developments and Key Issues.- E Special Problems of Adjustment in Developing Countries.- XVIII Special Problems of Adjustment in Developing Countries.- XIX Private Capital Flows and Developing Country Adjustment: Some Lessons of the Debt Crisis.- XX The Exchange Rate in the Adjustment Process of Less Developed Countries - a Multifarious Role.- XXI Foreign Lending Revisited 1880-1980.- F Concluding Address.- XXII Issues in International Economic Management.

According to data published by the Department of Commerce, the U.S. net international investment position (roughly the net external debt position with its sign reversed) at the end of 1987 was a negative $368 billion. This sum represents a deterioration of about $100 billion from the end-1986 level. The sharp downward plunge in the United States' net international investment position in recent years is, of course, a reflection of the large current account deficits recorded during most of the 1980s. In this paper, the U.S. net external debt position is examined and compared with the experience of other countries. The paper then proceeds to analyze the dynamic process of external debt accumulation. Concepts of external debt "stability" and "sustainable" external deficits are discussed. Next, a simulation model is developed with which various illustrative scenarios--involving alternative assumptions about exchange rates and demand growth--for the U.S. external accounts are generated and compared. Using these scenarios as background, the U.S. external adjustment process is discussed. Policy implications are then addressed, including the usefulness of focusing on the trade balance, rather than the current account, as the key indicator of external adjustment.

Exchange Rates, Prices, and External Adjustment in the United States and Japan

Global imbalances, external adjustment and propagated shocks: An African perspective from a global VAR model

I. Introduction During the 1997-98 East Asian financial crisis, the affected economies experienced a massive outflow of portfolio capital. To effect the transfer of such financial resources, the current account of the balance of payments underwent a dramatic reversal within a relatively compressed time period accompanied by massive reduction in domestic spending, sharp depreciation in the real exchange rate, and upward pressure on the real interest rate. This paper studies Malaysia's experience with current account reversal following the outbreak of the financial crisis. During the period 1997-98, the economy experienced a net short-term capital outflow of RM34.6 billion, representing 6.5 per cent of nominal gross national product (GNP). In response, the current account reversed itself from a deficit that averaged 6.2 per cent of GNP during the period 1990-97 to a surplus of 13.7 per cent in 1998. The magnitude of the current account reversal in Malaysia was the largest among the four East Asian economies that were most severely affected by the currency crisis. As Table 1 indicates, the current account in Indonesia reversed from an average deficit of 2.5 per cent of nominal gross domestic product (GDP) from 1993-97 to an average surplus of 4.6 per cent from 1998-2000, representing a reversal of 7.1 per cent. For Thailand, the switch-around in the current account amounted to 15.7 per cent of GDP. In contrast, Malaysia's external balance reversal during the same period amounted to 19.3 per cent of GDP. Such a massive turnaround in the current account, however, was accomplished with relatively less severe contraction in domestic demand. In 1998, economic activity in Malaysia contracted by 7.4 per cent compared with 13.1 per cent in Indonesia and 10.5 per cent in Thailand. Malaysia's current account reversal therefore appears to have been less painful in terms of the contraction necessary to achieve the reduction in domestic absorption to effect the transfer of resources abroad. Malaysia stood out among the crisis-hit countries as the only one that did not follow the conventional restrictive macroeconomic policy to stabilize the exchange rate and bring about improvement in the external balance. Instead the authorities chose to fix the exchange rate and impose capital controls, and pursued a moderate expansionary policy. Malaysia therefore presents an interesting case study of current account reversal, and this paper represents an attempt to provide a better understanding of the events following the outbreak of crisis and the adjustment process during the critical years of recovery. Section II of the paper analyses the dynamics of the external balance adjustment and how key macroeconomic variables shifted to facilitate the required real transfer employing an event-study approach. To complement the descriptive event-study findings, we estimate a structural vector autogression (SVAR) model in Section III to provide an econometric evaluation on the dynamics of the current account adjustment in response to shocks in relative prices and domestic income. Section IV summarizes the overall findings and draws some implications from the Malaysian experience on how the large current account deficit was reversed within a short period of time. II. Current Account Adjustment and Macroeconomic Performance An event-study approach to characterizing the dynamics of current account reversal would require an identification of the period before the external balance turned itself from a deficit to a surplus position and an analysis of the behaviour of the economy during the periods before and after the event. (1) The objective of such an analysis is to appraise the duration and the sustainability of the current account reversal and to evaluate how costly the adjustment process was in terms of macroeconomic performance. Using the criteria set out by Milesti-Ferretti and Razin (1998) for a significant and sustained turnaround in the external balance, (2) we identified the fourth quarter of 1997 as the period before the current account reversed into a surplus position (Figure 1). …

We study the process of external adjustment to large terms-of-trade level shifts—identified with a Markov-switching approach—for a large set of countries during the period 1960–2015. We find that adjustment to these shocks is relatively fast. Current accounts experience, on average, a contemporaneous variation of only about ½ of the magnitude of the price shock—indicating a significant volume offset—and a full adjustment within 3–4 years. Dynamics are largely symmetric for terms-of-trade booms and busts, as well as for advanced and emerging market economies. External adjustment is driven primarily by offsetting shifts in domestic demand, as opposed to variations in output (also reflected in the response of import rather than export volumes), indicating a strong income channel at play. Exchange rate flexibility appears to have played an important buffering role during booms, but less so during busts; while international reserve holdings have been a key tool for smoothing the adjustment process.

This study analyzed economic indicators, to assess patterns in Nigeria's GDP, poverty rate, and other key variables over a multi-year period, using a combination of predictive modeling, correlation analysis, clustering, and dimensional reduction techniques. The predictive analysis revealed a strong alignment between the observed and predicted values for GDP and poverty rates, with minor error margins and accuracy levels close to 100%, underscoring the model’s robustness in forecasting these economic indicators. Correlation analysis highlighted significant positive relationships between GDP and other variables, particularly importation, export, and exchange rates, while inflation and MPR showed moderate associations. Cluster analysis identified three distinct periods with economic similarity: 2014–2018, marked by stable growth; 2019–2022, likely influenced by external shocks or adjustments; and 2023, standing out as unique, potentially due to significant economic changes. The tDistributed Stochastic Neighbor Embedding (t-SNE) further validated these clusters by revealing distinct separations between the identified periods. The combined results offer insights into Nigeria’s economic patterns, revealing periods of stability and adjustment, and highlighting variables that significantly influence GDP and poverty, aiding policymakers in identifying trends and making data-informed decisions.

No Pain, All Gain? Exchange Rate Flexibility and the Expenditure-Switching Effect

We analyze how the pass-through from exchange rate to domestic wages depends on the degree of integration between domestic and foreign labor markets. Using data from 66 countries over the period 1981–2005, we find that the elasticity of domestic wages to real exchange rate is 0.1 after a year for countries with high barriers to external labor mobility, but about 0.4 in countries with low barriers to mobility. The results are robust to the inclusion of various controls, different measures of exchange rates, and concepts of labor market integration. These findings call for including labor mobility in macro models of external adjustment.