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Abstract
There is an ongoing debate about the role of exchange rates in facilitating external adjustment. This chapter explores how certain aspects of international trade, namely dominant currency pricing and international integration through global value chains, shape the working of exchange rates to induce external adjustment. The analysis suggests that the widespread use of the US dollar in trade pricing alters the short-term response of trade flows to exchange rate movements, with export volumes responding timidly to an exchange rate depreciation, while most of the adjustment takes place through import volumes. A more balanced adjustment process, through both export and import volumes, reemerges over the medium term. Meanwhile, greater integration into global value chains reduces the exchange rate elasticity of gross trade volumes, both in the short and medium term, but the associated increase in gross trade flows largely offsets this effect in most cases. Overall, the results suggest that while these features of international trade affect the composition and timing of the external adjustment process, for most countries, there remain benefits of exchange rate flexibility, especially in the medium term. With more muted effects of exchange rates on trade flows in the short term, complementary policies may be needed in some cases to support exchange rate flexibility and facilitate external rebalancing.
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