Exchange rate regimes and current account persistence

Abstract

AbstractWe empirically examine Friedman's hypothesis that floating exchange rates facilitate current account adjustments. The main innovation in the empirical analysis is to control for the sample selection bias. We provide robust evidence that current account persistence decreases with the flexibility of nominal exchange rate regimes and is significantly higher under hard pegs than under floating for industrial countries. The economic driving force of this finding is that the channel of the exchange rate adjustment mechanism dominates in affecting the real exchange rate persistence relative to its shock channel.