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.

How to Cope with Volatile Commodity Export Prices: Four Proposals

“…14 Empirically, floating delivers a high correlation between the exogenous price of the export commodity and the real effective exchange rate, thus accommodating terms of trade shocks, while fixing does not. A variety of empirical studies confirm that floating works better for countries exposed to volatility in the world prices of their export commodities: Broda (2004), Edwards and Levy-Yeyati (2005), Rafiq (2011), Céspedes and Velasco (2012) and Berg, Goncalves and Portillo (2016).…”

Systematic Managed Floating

“… Including Cashin, Céspedes, and Sahay (2004),Chen and Rogoff (2003), andFrankel (2007).34 IncludingBroda (2004),Edwards and Levy-Yeyati (2005),Rafiq (2011), andCéspedes and Velasco (2012).35 They include Baskaya, di Giovanni, Kalemli-Ozcan, and Ulu (2017), Cerutti, Claessens, and Puy (2015),Forbes and Warnock, 2012) andFratzscher (2012). Miranda-Agrippino andRey (2015) andRey (2015) trace these fluctuations in the global financial environment to changes in US monetary policy.Chari, Stedman and Lundblad (2017) find that the shocks do not show up in the quantity of capital flow so much as they drive EM asset prices.…”

The Currency-Plus-Commodity Basket: A Proposal for Exchange Rates in Oil-Exporting Countries to Accommodate Trade Shocks Automatically

“…(Examples of such commodity currencies include those of Australia, Canada, Chile, New Zealand, Russia and South Africa.) Furthermore, a number of studies have confirmed empirically that in the presence of large terms of trade shocks, economic performance tends to be better in countries with floating exchange rates than in countries with conventionally fixed exchange rates: Broda (2004), Edwards and Levy--Yeyati (2005), Rafiq (2011), and Céspedes and Velasco (2012). 5 The Gulf countries have opted for fixed exchange rates, either a peg to the dollar, as in the case of Saudi Arabia and the UAE, or a peg to a currency basket as in the case of Kuwait.…”