Abstract

Exchange rate regimes play a central role in macroeconomic stability, influencing trade competitiveness, capital flows, and external balances. In emerging economies, which are often more vulnerable to external shocks and capital market volatility, the choice of exchange rate regime—whether fixed, floating, or intermediate—can have significant implications for the trade balance and its volatility. Despite extensive theoretical debate, empirical evidence remains mixed, particularly for developing and emerging markets where structural and institutional differences may mediate these effects. This study aims to empirically assess how different exchange rate regimes influence the volatility of trade balances in emerging economies, drawing on a panel dataset spanning two decades.
The research employs a panel data econometric approach, using annual data from 30 emerging economies over the period 2000–2022. The exchange rate regime classifications are based on both de jure (legal/official) and de facto (actual practice) categorizations, primarily sourced from the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) and the Reinhart-Rogoff “Natural Classification.” The study utilizes measures of trade balance volatility—calculated as the standard deviation of the trade balance-to-GDP ratio over rolling 5-year windows—and links these with exchange rate regimes while controlling for other macroeconomic variables such as GDP growth, inflation, terms of trade, capital account openness, and monetary policy frameworks.
The empirical results suggest that floating exchange rate regimes are associated with higher trade balance volatility compared to fixed or managed regimes. This supports the theoretical argument that in a floating regime, the exchange rate absorbs external shocks, leading to more variable relative prices and potentially larger fluctuations in export and import values. However, the study also finds that in countries with well-developed financial markets and strong monetary policy credibility, the adverse volatility effects of floating regimes are significantly mitigated. Conversely, fixed regimes offer greater short-term stability but may lead to long-term misalignments in the real exchange rate, especially in the face of persistent terms-of-trade shocks or asymmetric demand pressures.