Discussion Paper Details

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Title: Do Exchange Rates Move to Address International Macroeconomic Imbalances?

Author(s): Matthew B Canzoneri, Javier Vallés Liberal and José Viñals

Publication Date: October 1996

Keyword(s): EMU, Exchange Rates and Optimal Currency Areas

Programme Area(s): International Macroeconomics

Abstract: This paper provides empirical evidence on the effectiveness of movements in nominal exchange rates in smoothing cyclical imbalances between countries, as explained by the literature on optimal currency areas. We use restrictions from the Mundell-Flemming model (on which the theory of optimal currency areas is based) to identify VAR systems that explain the exchange rate movements and the relative output movements of potential members of a European Monetary Union (EMU). We find that the shocks that cause most of the variation in relative output do not seem to result in movements in nominal exchange rates. Moreover, the shocks that explain movements in nominal exchange rates are monetary in nature, rather than real. Such results make it hard to argue that the loss of exchange rate flexibility accompanying EMU would come at a significant cost to macroeconomic stability.

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Bibliographic Reference

Canzoneri, M, Vallés Liberal, J and Viñals, J. 1996. 'Do Exchange Rates Move to Address International Macroeconomic Imbalances?'. London, Centre for Economic Policy Research.