Title Page
OCCASIONAL PAPER 235
A New Look at Exchange Rate Volatility and Trade Flows
Peter B. Clark, Natalia Tamirisa, and Shang-Jin Wei, with Azim Sadikov and Li Zeng
INTERNATIONAL MONETARY FUND
Washington DC
2004
Copyright
© 2004 International Monetary Fund
Typesetting & Production: IMF Multimedia Services Division
Figures: Jorge Salazar
Cataloging-in-Publication Data
A New look at exchange rate volatility and trade flows / Peter B. Clark … [et al]. — Washington, D.C. : International Monetary Fund, 2004.
p. cm. – (Occasional paper); 235
Includes bibliographical references.
ISBN 1-58906-358-9
1. Foreign exchange rates. 2. International trade. I. Clark, Peter B. (Peter Barton), 1941- II. Occasional paper (International Monetary Fund); no. 235.
HG 3821.N38 2004
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Contents
Foreword
I. Overview
II. A Brief Review of the Theoretical and Empirical Literature
Theoretical Aspects of the Relationship Between Exchange Rate Volatility and Trade
Empirical Results on the Relationship Between Exchange Rate Volatility and Trade
III. Recent History and Geography of Exchange Rate Volatility
Measuring Exchange Rate Volatility
Comparisons Using the Benchmark Measure of Volatility
Alternative Measures of Volatility
IV. New Evidence on the Effect of Exchange Rate Volatility on Trade
Aggregate Volatility and Aggregate Trade—A First Look
The Conceptual Framework for Analyzing the Volatility Effect in Trade
What the Data Tell Us
V. Summary and Concluding Remarks
Appendix: Determining Whether Countries with Stable Exchange Rates and a Common Currency Trade More
Statistical Appendix
References
Figures
3.1 Short-Run Effective Volatility of the Real Exchange Rate by Country Groups
3.2 Short-Run Effective Volatility of the Real Exchange Rate for the G-7 Countries
3.3 Short-Run Effective Volatility of the Real Exchange Rate in Developing Countries Grouped by Geographic Region
3.4 Short-Run Effective Volatility of the Real Exchange Rate in Two Developing Country Groups by Source of Export Earnings
3.5 Short-Run Effective Volatility of the Nominal Exchange Rate by Major Country Groups
3.6 Long-Run Effective Volatility of the Real Exchange Rate by Major Country Groups
3.7 Long-Run Effective Conditional Volatility of the Real Exchange Rate by Major Country Groups
3.8 Long-Run Effective Volatility of the Real Exchange Rate in the G-7 Countries
4.1 Effective Volatility of the Real Exchange Rate and World Trade
4.2 Effective Volatility of the Real Exchange Rate and Trade by Major Country Groups
4.3 Effective Volatility of the Real Exchange Rate and Trade of Developing Countries by Region
4.4 Effective Volatility of the Real Exchange Rate and Trade of Developing Countries by Type of Export
Tables
3.1 Short-Run Effective Volatility of Real IFS Exchange Rates in G-7 Countries by Major Country Groups
3.2 Average Effective Volatility Ranking, 1970–2002
3.3 Number of Years in Average Effective Volatility Ranking, 1970–2002
3.4 Real Effective Volatility Across Country Groups by Type of Exchange Rate Regime
3.5 Real Effective Volatility Across Regimes and Time Periods
4.1 Effect of Long-Run Real Exchange Rate Volatility on Aggregate Trade
4.2 Alternative Measures of Exchange Rate Volatility
4.3 Effect of Exchange Rate Volatility on Trade in Different Types of Products
Appendix Tables
A1 List of Countries in Major Country Groupings
A2 List of Countries in Regional Groups of Developing Countries and by Source of Export Earnings
A3 Correspondence Between the Official/IMF and Natural Regime Classification, 1970–2001
A4 Official Classification of the Distribution of Exchange Rate Regimes Across Country Groups, 1970–2001
A5 Natural Classification of the Distribution of Exchange Rate Regimes Across Country Groups, 1970–2001
A6 List of Countries in the Real Parallel Exchange Rate Data Set
A7 Short-Run Effective Volatility of Real IFS Exchange Rate: Smaller Sample of Major Country Groups
A8 Short-Run Effective Volatility of Real Parallel Exchange Rate: Smaller Sample of Major Country Groups
A9 The Role of Exchange Rate Volatility in Trade: Main Results
A10 Controlling for Endogeneity of Exchange Rate Volatility
A11 Alternative Measures of Volatility: Short Run and Long Run, Parallel Market, Nominal, and Conditional
A12 Country Pair–Fixed Effects
A13 Time-Varying Country Effects
A14 Differentiation by Product Type
A15 Differentiation by Country Type
A16 Summary Statistics and Correlations
A17 List of Countries in the Regressions with Disaggregated Trade, 1975–2000
A18 Classification of Products into Homogeneous and Differentiated Categories
Foreword
This study examines the effect of exchange rate volatility on trade, and was prepared in response to a request to the IMF from the Director General of the World Trade Organization (WTO). The IMF produced a study in 1984 for the General Agreement on Tariffs and Trade (GATT) on this subject. Since then, there have been major developments in the world economy, some perhaps having exacerbated fluctuations in exchange rates whereas others likely having reduced the impact of volatility on trade. It is therefore appropriate to revisit the issue some 20 years later.
Overall, there is no robust evidence of a large negative effect of exchange rate volatility on trade. This suggests that, from the perspective of enhancing trade, exchange rate volatility is not likely to be a major policy concern. This does not rule out the possibility that a large exchange rate volatility could affect an economy through other channels.
This study was prepared by a team led by Peter B. Clark and Shang-Jin Wei and consisted of Natalia Tamirisa, Azim Sadikov (summer intern), and Li Zeng (research assistant). It has benefited from comments from Mary Amiti, Giovanni Dell’Ariccia, Raghuram Rajan, Stephen Tokarick, Management, and various departments of the IMF, as well as from Marc Auboin, Richard Eglin, and other staff of the WTO. Miklos Koren, Andrew Rose, Adam Szeidl, and Silvana Tenreyro generously shared their data. Marlene George, Celia Burns, and Laura Leon provided able assistance. Gail Berre of the External Relations Department edited the paper and coordinated the production of the publication. The views expressed are those of the authors and do not necessarily reflect the views of national authorities or IMF Executive Directors.
Raghuram G. Rajan
Economic Counsellor and Director
IMF Research Department