Research Discussion Paper – RDP 9811 Effective Real Exchange Rates and Irrelevant Nominal Exchange-rate Regimes
October 1998
Abstract
We examine the relationship between the short-term volatility of the effective Real Exchange Rate (RER) and the degree of flexibility of the nominal exchange rate. Existing evidence demonstrates that the short-term variance of bilateral RERs is on average about 12 times higher under floating nominal exchange rate regimes than under fixed regimes. By comparison, based on pooled results across a set of countries with low and stable inflation and stable growth rates from 1978 to 1994, the effective RER is only twice as volatile under floating regimes compared with fixed regimes. Although this difference is statistically significant, results within countries show that for most countries there was no significant increase in effective RER volatility when moving to more flexible exchange-rate regimes. Surprisingly, there are even some countries for which volatility is lower under more flexible exchange-rate regimes. In part our findings reflect the fact that effective RERs are an average of bilateral RERs. Also, we suggest that there is a difference between a fixed exchange-rate regime during Bretton Woods and a fixed exchange-rate regime post-Bretton Woods.