Description:
The "New Open Economy
Macroeconomics" argues that: (a) non-monetary factors
have gained importance in explaining exchange rate
volatility, and (b) trade and financial openness may have a
potential role of mitigating and/or amplifying real and
nominal shocks to real exchange rates. The goal of the
present paper is to examine the ability of trade and
financial openness to exacerbate or mitigate real exchange
rate volatility. The authors collected information on the
real effective exchange rate, its fundamentals, and (outcome
and policy measures of) trade and financial openness for a
sample of industrial and developing countries for the period
1975-2005. Using instrumental variables techniques, the
analysis finds that: (a) High real exchange rate volatility
is the result of highly volatile productivity shocks, and
sharp oscillations in monetary and fiscal policy shocks. (b)
Countries more integrated with international markets of
goods and services tend to display more stable real exchange
rate fluctuations. (c) Financial openness seems to amplify
the fluctuations in real exchange rates. (d) The composition
of trade and capital flows plays a role in explaining the
smoothing properties of trade and financial openness.
Although the former is mainly driven by manufacturing trade,
the latter depends on the share of debt (and equity) in
total foreign liabilities. (e) Financial openness would
attenuate (magnify) real exchange rate volatility, the
greater the share of equity (debt) in foreign liabilities.
(f) The composition of flows also matters for explaining the
smoothing properties of trade and financial openness in
periods of currency crisis.