Exchange Rate Regimes and Economic Linkages

• Published in: International economic journal Vol. 24; no. 1; pp. 1 - 23
• Main Authors: Lee, Jong-Wha, Shin, Kwanho
• Format: Journal Article
• Language: English
• Published: Routledge 01.03.2010; Korean International Economic Association; 한국국제경제학회
• Series: International Economic Journal
• Subjects: consumption co-movement; Exchange rate determination; Exchange rate policy; Exchange rate regime; Exchange rates; International finance; International monetary economics; International trade; output co-movement; Risk sharing; Trade; 경제학
• ISSN: 1016-8737; 1743-517X
• DOI: 10.1080/10168731003589741

We investigate how the exchange rate regime influences economic linkages between countries. We divide the exchange rate regime into three classifications: currency union, peg and floating exchange rates. Unlike most studies that solely focus on the relationship between anchor and client countries, we infer the exchange rate regime between any two countries based on their relationship to the common anchor currency. Then we empirically explore how the various exchange rate regimes impact on bilateral trade, output co-movement and risk sharing. The extent of risk sharing is measured by consumption co-movement relative to output co-movement. We find that while currency union has the greatest effect, the peg regime also significantly boosts trade. We also find that while the peg regime contributes to both output and consumption co-movements, currency union strengthens only consumption co-movement and possibly lowers output co-movement. We interpret these findings to indicate that currency union, the strictest form of pegged regimes, leads to higher industry specialization and better risk sharing opportunities than the less strict peg regime.