Exchange rates as shock absorbers: The role of export margins

Abstract

This study addresses the role of floating exchange rates as shock absorbers when trade involves previously traded goods (intensive margin) as well as new goods and previously non-traded goods (extensive margin). In a panel VAR model of 23 developed economies, we first document that adjustment to real shocks occurs mainly at the extensive margin and particularly so in fixed regimes. This in turn amplifies output fluctuations. We then propose a model with firm entry and endogenous selection of exporters that generates dynamics in line with the estimated responses.