Essays on Economic Variability, Dynamics of Adjustment, and Exchange Rate Flexibility

Abstract

This dissertation revisits the literature on the role of exchange rate flexibility in smoothing the adjustments of the economy to different disturbances. Recently, the role of flexible exchange rates in stabilizing the economy against real shocks has been challenged by the new open economy models, which build on some empirical regularities, such as the low pass-through from nominal exchange rates to import prices. We take three approaches in an attempt to enrich this literature. Firstly, we incorporate factors of production into welfare analyses of fully-specified general equilibrium models. We find flexible exchange rate regimes reduce terms of trade and consumption volatility for primary commodity economies, particularly oil-exporting. Secondly, in an empirical investigation, using a panel Vector Autoregressive Regression of nine of the OECD's major oil-importing countries and the Reinhart and Rogoff's de facto classification of exchange rate regimes, we find support for the hypothesis that flexible exchange regimes better absorb oil-price shocks. We also document feedback from the real effective exchange rate and inflation rate to the domestic-currency real oil price shocks, supporting the growing notion that oil price shocks are not purely exogenous to developed economies. Thirdly, in a micro-level empirical investigation, we find a significant improvement in estimating the degree of nominal exchange rate pass-through to import prices when the adjustment costs and the equilibrium degree of pass-through assumptions are considered. More specifically, using a vector threshold cointegration model, we find increases in both the initial reaction and the long-run equilibrium response of import prices to nominal exchange rate changes for five industries in 16 OECD countries, especially for the manufacturing industry.