Working Paper: CEPR ID: DP729
Authors: Tamim Bayoumi; Barry J. Eichengreen
Abstract: We use time-series methods to estimate a simple aggregate supply and demand model in order to analyse the comparative performance of fixed and flexible exchange rate systems and test competing hypotheses designed to explain shifts between exchange rate regimes. The paper provides a coherent explanation of the causes and consequences of the shift from the Bretton Woods System of pegged exchange rates to the post-Bretton-Woods float. The shift from fixed to floating was associated with a modest increase in the cross-country dispersion of supply shocks, but not with an increase in their average magnitude. There was little change in either the cross-country dispersion or the average magnitude of demand shocks. More important in explaining the collapse of Bretton Woods were factors that heightened the impact of shocks on the external account such as the 1958 removal of controls on current account convertibility and the declining effectiveness of capital controls. These factors obliged governments to respond to supply shocks with changes in demand that stabilized prices and the exchange rate at the expense of increased output volatility.
Keywords: exchange rates; economic adjustment; regime changes; bretton woods; floating rates; supply shocks; demand shocks
JEL Codes: F31; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| shift from fixed to floating exchange rates (F33) | increase in cross-country dispersion of supply shocks (F69) |
| shift from fixed to floating exchange rates (F33) | changes in price responses to shocks (E39) |
| collapse of the Bretton Woods system (F33) | heightened impact of shocks on external account (F32) |
| supply shocks (E39) | government responses to stabilize prices and exchange rate (F31) |
| fixed exchange rates (F31) | monetary policy adjustments required to stabilize the exchange rate (E63) |
| fixed exchange rates (F31) | flattening of the aggregate demand curve (E00) |
| flattening of the aggregate demand curve (E00) | increase in output response (E23) |
| flattening of the aggregate demand curve (E00) | reduction in price response to supply shocks (E39) |
| floating exchange rates (F31) | steepening of the aggregate demand curve (E00) |
| steepening of the aggregate demand curve (E00) | increase in price volatility relative to output (E39) |