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Exchange Rate Regimes and Current Account Adjustments in Emerging Markets: An Empirical Investigation
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Exchange Rate Regimes and Current Account Adjustments in Emerging Markets: An Empirical Investigation
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Journal Article
Exchange Rate Regimes and Current Account Adjustments in Emerging Markets: An Empirical Investigation
2025
Overview
This article aims to empirically examine the validity of two related hypotheses in the context of emerging markets. The first suggests that the flexibility and adjustment of the real exchange rate promote external stability, while the second posits that a flexible exchange rate facilitates such adjustment. To achieve this, two empirical methodologies are employed: first, an event analysis is used to identify current account adjustment episodes during the 1980–2021 period. Then, an econometric technique is applied to estimate the impact of exchange rate regimes on the current account imbalances: the System Generalised Method of Moments. The study concludes that countries with more flexible exchange rate regimes tend to experience smaller and less costly external imbalances. Moreover, the econometric analysis indicates that current account adjustments occur more rapidly in these countries compared to those with fixed or intermediate exchange rate regimes. These results suggest emerging markets should consider adopting more flexible exchange rate regimes to enhance external stability and reduce the economic costs of persistent imbalances. Policymakers could also enhance long-term economic stability and reduce the impact of external shocks by adopting counter-cyclical fiscal policies and creating sovereign wealth funds.
