Sources of economic fluctuations in oil-exporting economies: implications for choice of exchange rate regimes

Abstract

If a country is dependent on one particular export commodity, what exchange rate policy should it follow? Surprisingly, there is no standard textbook prescription for such a country. In theory, rigidly pegging exchange rates to those of the developed economies allow emerging markets to fix the price of tradable goods and import monetary policy credibility leading to greater macroeconomic stability. The corollary being that countries lose their ability to react independently to domestic economic concerns. Nowhere are these macroeconomic policy dilemmas currently more acute than for emerging market oil-exporting economies, with their pegged exchange rates making it difficult to adjust to swings in the high price of crude oil. This paper investigates whether through rigidly fixing the exchange rate it is now the case that the disadvantages associated with importing a monetary policy ill-suited to the need of oil-exporting countries, now outweigh the gains from importing US monetary policy. The results in this paper show that pegged regimes are poor at insulating emerging market commodity-dependent economies from real shocks, in particular terms-of-trade disturbances. Allowing for caveats, the results show that greater macroeconomic stability could be fostered in emerging market oil-exporting economies by allowing for greater flexibility in their exchange rate regimes. Copyright © 2010 John Wiley & Sons, Ltd.