Working Paper: NBER ID: w10696
Authors: Michael W. Klein; Jay C. Shambaugh
Abstract: A classic argument for a fixed exchange rate is its promotion of trade. Empirical support for this, however, is mixed. While one branch of research consistently shows a small negative effect of exchange rate volatility on trade, another, more recent, branch presents evidence of a large positive impact of currency unions on trade. This paper helps resolve this disconnect. Our results, which use a new data-based classification of fixed exchange rate regimes, show a large, significant effect of a fixed exchange rate on bilateral trade between a base country and a country that pegs to it. Furthermore, the web of fixed exchange rates created when countries link to a common base also promotes trade, but only when these countries are part of a wider system, as during the Bretton Woods period. These results suggest an economically relevant role for exchange rate regimes in trade determination since a significant amount of world trade is conducted between countries with fixed exchange rates.
Keywords: fixed exchange rates; trade; currency unions
JEL Codes: F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fixed exchange rate (F31) | Bilateral trade (F10) |
| Indirect pegs (F31) | Bilateral trade (F10) |
| Fixed exchange rate (F31) | Trade (compared to dyads without fixed exchange rate) (F31) |