Exchange Rate Risk, Exchange Rate Regime and the Volume of International Trade

KYKLOS,Vol. 41, 1988, Fax. 2,263-280

Exchange Rate Risk, Exchange Rate Regime and the Volume of International Trade

JOSEF C. BRADA * and JOSE A. MENDEZ **

1. INTRODUCTION

Proponents of fixed exchange rates have argued that flexible exchange rate regimes depress the volume of international trade in two separate ways. First, to the extent that flexible exchange rate regimes are characterized by unanticipated exchange rate fluctuations, importers and exporters will be subject to greater exchange rate risk and therefore less willing to engage in international trade I . Second, it is claimed that unanticipated exchange rate volatility will induce governments to erect either generalized or sectoral trade barriers. Such barriers would be erected in order to offset the destabilizing effects of changes in exchange rates that do not reflect changes in incomes, prices and other fundamental determinants of comparative advantage and international trade. This assessment is based largely on experiences with floating exchange rates in the inter-war period

* ** Associate Professor of Economics, Arizona State University and Economist,

United States International Trade Commission. The views expressed in this paper are solely those of the authors and do not neces-

sarily reflect the views of the United States International Trade Commission. We would like to thank JOHN K.HILL, MICHAEL MELVIN, JAMES REITZFS and DONALD ROUSSLANG for helpful comments.

1 . CLARK [1973], ETHIER [1973], BARON [1976] and HOOPER and KOHLHAGEN [1978].

263

Professor of Economics, Arizona State University

JOSEF C.BRADA AND JOSE A.MENDE2

and, more recently, during the period following the breakdown of the Bretton Woods system2.

Proponents of flexible exchange rates argue that flexible exchange rates will increase the volume of trade over that attainable under fixed rates 3 . Regarding exchange rate variability, they argue that, because destabilizing speculation is unprofitable, exchange rates will move in response to changes in fundamental determinants of trade. Moreover, such changes in the fundamentals would require similar, but more abrupt and crisis-ridden, changes in fixed parities. Conse- quently it is not evident that a system of fixed rates will yield less unanticipated exchange rate volatility than would floating rates. Proponents of flexible rates also argue that fixed rather than floating rates encourage governments to raise protective tariff barriers thus reducing the volume of international trade. Countries with flexible exchange rates achieve payments equilibrium through exchange rate changes and consequently do not need to restrict imports through commercial policy measures. In contrast, fixed exchange rate countries must achieve equilibrium by changes in domestic incomes and prices or by means of restrictions on imports. Since the former are less palatable politically than the latter, and because many countries with fixed exchange rates have overvalued currencies, the demand for imports is controlled by means of tariff and non-tariff barriers 4.

Two recent surveys of the empirical research on the effect of the exchange rate regime on the volume of trade, IMF [1984a] and THURSBY and THURSBY [1985], conclude that there is some, albeit mixed and controversial, evidence that exchange rate variability does

2. The vicious and virtuous circle literature of the 1970s suggests the desirability of protectionism under flexible rates, while BERGSTEN and WILLIAMSON [ 19831, MCKIN- NON [1984], and others raise the connection between exchange rate volatility and protectionist pressure in recent years. CLIFTON [ 19851 and MCCULLOCH [1986] provide a critical assessment of the alleged connection.

3. The classic exposition of this view is FRIEDMAN [1953]. Also see WILLETT [1977]. 4. This is particularly so in the case of developing countries where fixed rates are

frequently accompanied by exchange controls, import licensing and other non-tariff barriers as well as by tariffs. See BHAGWATI [1978], KRUEGER [1978], NOWAK [1984] and WICKHAM [ 19851. The fact that some countries may have undervalued currencies does little to raise the volume of trade since it is the short end of the market, the demand of overvalued currency countries with extensive import restrictions, that determines the actual volume of international exchanges.

264

EXCHANGE RATE AND THE VOLUME OF INTERNATIONAL TRADE

reduce the volume of international trade 5 . The studies surveyed focus on the relationship between the risk created by exchange rate instability and the decisions of traders to reduce the volume of international exchanges. Because of this emphasis on the connection between instability and risk, they do not take into account the relationship between the exchange regime and the restrictiveness of commercial policy. The failure to account for the commercial policy effects of exchange regimes makes it difficult to draw conclusions about the relative merits of fixed and flexible exchange rates. For example, even if a study shows a negative relationship between risk and the volume of trade over time, such a finding cannot be used to conclude that the volume of trade is greater under a fixed regime than under a floating one, only that under a floating regime less risk increases the volume of trade.

In addition to the failure to take into account the possible interac- tion between exchange regime and commercial policy, the existing empirical work on the relationship between exchange rate volatility and the volume of trade suffers from a number of other shortcomings. Although previous studies differ in country coverage and time period over which parameters are estimated, they do share a common research methodology. The essence of this methodology is to incor- porate some measure of exchange rate instability into a traditional specification for the determination of aggregate or disaggregated trade flows6. If the coefficient associated with the measure of exchange rate variability is negative, researchers have concluded that floating rates have a negative impact on the volume of foreign trade. There are several difficulties with this methodology and the conclusions that can be drawn from it. First, it is not exchange rate variability but rather unanticipated variability that increases risks to traders and reduces the volume of trade. It is unlikely that expost measures of

5 . Among the work published since the appearance of these surveys is that of GOTUR [1985], who finds no conclusive evidence of the effects of exchange rate variability on the volume of international trade and KENEN and RODRIK [I9861 who find that volatility in real exchange rates does depress the volume of trade. They, however, do not compare their results with changes in the volume of trade under fixed exchange rate regimes.

6. For a tabular survey of these studies, see THURSBY and THURSBY [1985, Table

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10. I.].

JOSEF CBRADA AND JOSE A.MENDEZ

exchange rate variability are good proxies for ex ante perceptions of unanticipated risk ’. The time-series nature of the studies also creates problems because the 1970s and early 1980s were a period of volatile changes in incomes, inflation rates and relative prices in the countries covered by these studies. Thus it is unclear whether stable relationships between trade and other explanatory variables should hold in these studies or whether exchange rate variability merely serves as a proxy for other forms of volatility that served to reduce the volume of trade but were omitted from these models. Finally, it is important to bear in mind that studies based on the aggregate volume of trade of the sample countries may well draw their conclusions about the effect of flexible exchange rates from trade flows that are transacted under a combination of exchange regimes. That is, under today’s international financial arrangements most countries trade at fixed rates with some partners and at floating rates with others. Consequently the analysis needs to be carried out at the level of bilateral rather than aggregate trade flows.

In this paper we test whether flexible exchange rates reduce the volume of international trade more than do fixed rates. Our approach is unique in two ways. First, our test does not make use of proxies for unanticipated exchange rate fluctuations, and, second, it enables us to shed light on the previously unexplored relationship between exchange rate regime and the restrictiveness of commercial policy. The model is set out in the following section. In Section 11, we report our estimates and present our conclusions regarding the effect of exchange rate regimes on the volume of international trade.

7. For example, fluctuations in exchange rates under floating rates due to differences in rates of inflation may be anticipated by traders with no resultant effects on trade due to unanticipated risk. Under fixed rates, there might be no observed exchange rate variability but significant unanticipated risk due to traders’ uncertainty over the timing of a devaluation.

In general, ex post exchange rate variability is a poor indicator of unanticipated risk because other sources of risk in the economic environment may simultaneously affect both the volume of trade and the exchange rate. As IMF [1984a, p.331 notes: ‘This impact on exchange rate relationships may magnify or offset the direct impact on trade flows, but in any event it will not be related in a simple manner to any straight- forward measure of exchange rate variability’. A similar argument was made by FRIEDMAN [1953] and has been repeated by others. See WILLETT [1977] for further references.

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11. THE MODEL

Our approach is based on the fact that the international system that evolved after the breakdown of the Bretton Woods system is not a pure textbook example of either fixed or floating rates. Rather a country's currency may be simultaneously fixed against one or more currencies while floating against others '. Consequently the trade flows of countries with fixed rates include both transactions carried out at fixed rates and transactions carried out at floating rates. A comparison of these flows should reflect the consequences of greater exchange rate risk on the volume of international trade. Similarly, countries with floating rates trade both with countries having fixed parities and with floating currency countries. Differences between the volume of trade with the two types of partners should reflect systematic differences in commercial policy between fixed and floating regime countries.

To model bilateral trade flows between nations, we use the so- called gravity model of bilateral trade flows. We choose this model because it provides an empirically tractable general equilibrium model of bilateral trade flows that has a sound theoretical basis and that has proved useful in a variety of applications9. The model is specified as:

8. The IMF groups the exchange rate arrangements of member countries into five categories: (i) countries that peg their currency against a single currency such as the dollar, pound, or French franc, (ii) countries pegged to a composite of currencies such as the SDR or a trade weighted average of the currency of their principal trading partners, (iii) countries that float independently, (iv) countries which as a group float, yet are pegged to the currencies of other members in the group; and (v) countries that change their exchange rate according to a set of indicators. IMF [1984b] further groups the latter into three categories: pegged, flexibility limited vis-a-vis a single currency or group of currencies, and more flexible.

9. The gravity model has a well established record of success in explaining trade flows. Among the many empirical studies, see TINBERGEN [1962], LINNEMANN [1966], AITKEN [1973], and GERACI and PREWO [1977], BRADA and MENDEZ [1985]. The development of a strong theoretical foundation begun by ANDERSON [ 19791 has recently culminated in two seminal contributions by BERGSTRAND [1985 and 19861.

The gravity model was also used by ABRAMS [1980] to test for the effects of exchange rate volatility on bilateral trade flows. This study differs from ours in several important respects. First, ABRAMS employs ex post exchange rate variability as a

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JOSEF C.BRADA AND JOSE A.MENDEZ

In Xij = a + b, In Yi + b21n Y , + b, lnN, + b,lnN, -t c1 In Dij + c2 In PRFij + d, In FIXi + d, In FIX, + d3 In FLOAT,, + Uij

value of exports from country i to country j income of the exporting (importing) country population of the exporting (importing) country distance between countries i and j dummy variable equal to 2 if i and j belong to the same preferential trading area; 1 otherwise dummy variable equal to 2 if the exporting (importing) country pegs its exchange rate to any currency; 1 otherwise

FLOAT,, = dummy variable equal to 2 if the bilateral exchange rate between country i and country j is flexible; 1 if the bilateral exchange rate between i and j is fixed

u.. = lognormal error term.

Theory, verified by previous empirical results, suggests that bilateral trade between two countries is positively related to their respective incomes and negatively to the distance between them, LEAMER and STERN [1970, pp. 152-1531. The expectations regarding the effect of population are mixed, as are the empirical results. Since two countries belonging to a preferential trading scheme should have lower than average barriers against bilateral trade, it is expected that cz is positive.

The effect of exchange rate regime on the volume of trade between any two countries depends on the exchange rate regime each country employs and the resultant relationship between their currencies. The possibilities and the way in which they are modeled by means of the dummy variables are set out in Table I . The first three cases in Table I are symmetrical in their effects, meaning that the effects on country i and j are the same. Cases 1 and 2 represent the two pure cases; classical floating and fixed exchange rates. If the commercial policy and the degree of price and exchange rate uncertainty under fixed rates reduces the volume of trade relative to that under flexible rates then

measure of ex ante risk. Second, ABRAMS pools data across a number of years; as we show below, such pooling is not permissible for our sample. Finally, our sample of countries is considerably larger than ABRAMS’.

268

Table I

Summary of Trade Regimes, Dummy Variables and Effects on Bilateral Trade Flows

rn E

P Exchange Rate Regime Dummy Variables 4 n

$ 1 Float Float 1 1 2 zd3 u Case Country i (exporter) Country j (importer) Fix, Fixj Floatij Effect on Bilateral Trade

2 Fixed Fixed against country i 2 2 1 2d1 + d2

or against a common currency

common currency or each other or against key currencies that are fixed against each other

2d1 + di + d3 3 Fixed Fixed but not against a 2 2 2

4 Float Fixed against country i 1 2 1 2d' 5 Fixed against country j Float 2 1 1 2d' 6 Float Fixed but not against country 1 2 2 2d2 + d3

i's currency I Fixed but not against Float 2 1 2 2d1 + d3 4

P > u n

country j's currency


d, + d, < d,. Table I also lists four asymmetric cases. In these cases, 4 7 , the effect of a regime on a country’s exports is different from the effect on imports. For example, a Latin American country that pegs to the United States dollar would have its exports to the United States modeled unter case 5 , and the volume of exports raised or lowered by 2d’ while its imports from the United States would be modeled under case 4, and their volume would be adjusted by 2dZ. This asymmetric effect on imports and exports arises from two sources. First, exchange risk may differ between exporters and importers, and, second, the commercial policy of a fixed exchange rate country may influence the volume of imports and of exports differently.

The coefficient d, is estimated on the basis of bilateral trade flows falling under cases 1, 3, 6, and 7. In these cases we observe trade between floaters, between fixers and floaters, as well as between fixers where the bilateral exchange rate is not fixed. Thus, in each case the bilateral trade flow occurs between countries whose respective currencies directly or indirectly float against one another and where the amount of exchange uncertainty is different from that when there are fixed exchange rates between the two trading countries. The coefficient estimate d, is therefore a ceterisparibus measure of the effects of the increased exchange rate uncertainty as reflected by the shortfall in trade experienced by traders in floating rate transactions over and above that experienced in otherwise identical transactions at fixed rates. However, note that even though the value of d, is, unlike the estimates of other studies, determined by the ex ante uncertainty experienced by traders and the effect that this uncertainty has on the volume of their exchanges, our estimate differs from that of other exchange rate volatility studies in another way. Other studies essen- tially capture a ‘pure’ risk effect arising only from the variability of the exchange rate. The estimate in this study instead reflects the effect on the volume of trade of differential risk, since the alternative that it is measured against (when the dummy variable is off) is trade under pegged rates with all its attendant risks. In other words, unlike other studies, the alternative is not a situation absent of any exchange rate risk. It also differs from that of other studies by not employing an ex post measure of exchange-rate variability.

The value of d, is estimated on the basis of trade flows in cases 2 , 3 , 5, and 7, all cases where the exporter has a fixed exchange rate regime. 270


Since the exchange regime and hence its effect on the commercial policy of the importing country is controlled for by FIXj and any exchange risk is captured by FLOAT,,, d, measures the difference, ceteris paribus, between the export flows of fixed and floating exchange rate countries lo. If there were no difference between the export performance of fixers and floaters in their trade with an identical partner with an identical degree of exchange rate risk, d, would be zero; a negative value would indicate that, ceteris paribus, countries with fixed exchange rates export less than do those with floating rates. The reasoning for d, is similar. Consequently d, and d, indicate the differential impact of fixed rates on the volume of imports and exports through the relationship between exchange rate regime and commercial policy.

111. RESULTS

Equation (1) was estimated for each year from 1973 to 1977 on the basis of bilateral trade flows among thirty developed and developing countries. The period 1973-1977 was chosen because it includes both turbulent and tranquil periods of exchange rate volatility and ex ante risk. The study could not be continued beyond 1977 because the reporting of small trade flows changed in 1978 making results for subsequent years non-comparable. The sample of countries was chosen with a view toward obtaining a sufficiently wide range of exchange regimes, country size and level of development. The countries in the sample and their exchange rate regimes as classified by the IMF are reported in Table 2. Data sources and units of measurement are reported in the Data Appendix.

Parameter estimates are presented in Table 3. The coefficients for income, inter-country distance, and membership in a preferential

10. In practical terms, the dummy variable FIXi is turned on irrespective of the particular bilateral exchange rate relationship between the exporting country and a trading partner. We adopt this specification because we expect the trade policies associated with an exchange regime to be nondiscriminatory. Thus d, captures the systematic effect on bilateral trade flows due to commercial or other policies associated with an exporting country that has adopted a fixed exchange rate regime.

27 1


Table 2

Exchange-Rate Arrangements for Sample Countries 1973-1977

Fixed Flexible Pegged to the Cooperative Independent or U.S. dollar Arrangement Managed Floating

European Monetary System

Argentina (73-74) Bolivia Costa Rica (74) Ecuador Egypt El Salvador Guatemala Honduras Mexico (73-75) Nicaragua Paraguay Peru (73-75) Spain (73) Venezuela

Austria Denmark Germany (FR) Netherlands Norway Sweden

Argentina (75-77) Belgium-Luxem bourg Brazil Chile Colombia France Italy Mexico ( 7 6 7 7 ) Portugal Peru (7677) Spain (74-77) Switzerland United Kingdom Uruguay

Source: International Monetary Fund, Annual Report on Exchange Arrangements & Exchange Restrictions, various issues.

trading area are all significant, have the expected signs and in general do not differ from values reported by other researchers. The population coefficients display a less consistent pattern of significance, also in keeping with the findings of others. Noteworthy is the instability of coefficients from year to year, similar to the instability found by AITKEN [1973] and BRADA and MBNDEZ [1985]. A Chow test con- firmed that the coefficients varied sufficiently from year to year to preclude pooling the sample over time.

With the exception of the value of d, for 1975, all the coefficients characterizing the effects of exchange rate regimes on bilateral trade flows are significant at the 5 percent level. For all years d,>d,+d, indicating that bilateral trade flows between two countries with floating rate regimes were greater, ceteris paribus, than between two 272


countries with fixed exchange rates. Table 4 shows the volume of bilateral trade expected under each of the possible combinations of exporting and importing country exchange regimes described in Table I. The volume of trade achieved between two countries with floating rates in each year is set equal to 100 to facilitate comparison. Thus, over the sample period countries with fixed rates achieved levels of bilateral trade from 27 to 61 percent of those achieved be-

Table 3

Gravity Equation Parameter Estimates Dependent Variable: Volume of Exports Country i to Country j

Independent Variables

~~ ~~

1973 1974 1975 1976 1977

Intercept 8.277 3.695 5.680 5.911 7.358

y, 0.336 0.764 0.688 0.555 0.479

Y j 0.418 0.520 0.345 0.460 0.393

Ni 0.682 0.104 0.097 0.205 0.291

Nj 0.226 0.053 0.229 0.162 0.227

(7.4) (3.7) (5.2) (5.6) (6.6)

(4.8) (10.6) (8.3) (7.6) (6.7)

(5.1) (6.9) (4.5) (7.3) (6.2)

(6.9) (1.0) (0.9) (2.1) (2.7)

(2.2) (0.6) (2.6) (2.0) (2.6) Dij - 0.887 - 0.801 - 0.742 - 0.743 - 0.775

(- 10.1) (- 10.7) (- 9.5) (- 9.2) (- 8.3) PRF,, 1.341 1.037 0.882 0.746 0.784

(3.9) (3.7) (3.0) (2.4) (2.1) FIXi - 0.785 - 0.499 - 1.277 - 1.368 - 1.919

(- 2.7) (- 2.2) (- 5.5) (- 5.3) (- 6.6) FIX, - 1.749 - 0.869 - 0.749 - 0.490 - 0.839

(-5.4) (-3.2) (-2.5) (-1.5) (-2.3) FLOAT,, - 1.247 - 0.594 - 0.309 - 0.729 - 0.851

(-3.9) (-2.2) ( - i . 1 ) (-2.5) (-2.4) RZ 0.7093 0.7842 0.7681 0.7326 0.6845 F-ratio 122.52 184.52 168.95 137.62 110.65 Observations 462 466 469 462 469

Note: T-ratio in parentheses.

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Table 4

Effect of Exchange Rate Regime on the Volume of Bilateral Trade

Case Exchange Regime Relationship Volume of Bilateral Trade Exporting Importing Between (Floating Regime = 100) Country Country Currencies

1973 1974 1975 1976 1977

1 Float Float Float 100 100 100 100 100 2 Fixed Fixed Fixed 51 61 30 46 27 3 Fixed Fixed Float 17 39 25 28 15 4 Float Fixed Fixed 71 83 82 118 101 5 Fixed Float Fixed 138 107 5 1 64 48 6 Float Fixed Float 30 55 60 71 56 7 Fixed Float Float 58 71 41 39 26

Source: Calculated according to Tables 1 and 3.

tween countries with floating rates. Since both fixed and floating rates could be adopted on a worldwide basis, the relative magnitudes of these bilateral trade flows may be interpreted as estimates of the volume of world trade that could be achieved under either exchange regime.

The regime most inimical to a high volume of international trade is Case 3 where each of the countries pegs to a different key currency, and the key currencies float against each other ' I . In this situation, both the importer and exporter suffer from what our evidence suggests are strong anti-trade commercial policies found in fixed exchange countries as well as from exchange rate risk caused by floating rates. On the other hand, for some years cases 4 and 5 , which together constitute a possible trade regime for some, although not all, countries generated volumes of bilateral exchanges higher than those achievable under pure floating. Case 5 , which represents, for example, the situation of those Latin American countries that fixed their currency to the dollar, generates the highest bilateral trade flows in

11 . An example would be a Latin American country that pegs to the U.S. dollar trading with a country that pegs to sterling as India did for a number of years.

274


1973 and 1974. One way to interpret this result is that due to the fixed rate there were low exchange risks relative to the risks faced by traders in floating currency countries and that the floating of the importing country’s currency obviated the need for it to adopt restrictive commercial policies. The decline of the efficiency of this regime in the latter part of the sample period may reflect above-average rates of inflation in the exporting countries that were not reflected in changes in their exchange rates, thus reducing competitiveness or creating exchange risk for traders. Exporters with floating currencies exporting to countries that pegged to the exporter’s currency also achieved superior results, although these came in 1976 and 1977. This is consistent with the above hypothesis that fixed regime countries failed to adjust their exchange rates so as to account for domestic inflation. Finally, comparing cases 4 and 5 to cases 6 and 7 it is evident that in trade between floating and fixed exchange rate countries, the volume of bilateral exchanges was higher when there were fixed rates between the two countries. This is not to be seen as due to the fact that countries are likely to peg to major trading partners rather than to countries with which bilateral exchanges are low. Because our model accounts for country size and proximity, two major determinants of trading partners, and because we exclude Latin American-United States trade from the sample, this self-selection should not be a source of bias.

Finally, the estimates of d, can be used to determine whether ex post measures of exchange rate instability can serve as good proxies for ex ante exchange risk. Recall that d, measures the reduction in trade due to the added risk borne by traders in floating rate transactions over and above that experienced in fixed rate transactions. Thus a decrease in d, from one year to the next implies a ceteris paribus decline in trade flows transacted between countries with bilaterally floating currencies. If ex post exchange rate variability were a good measure of ex ante risk, declines in d, should be associated with increased exchange rate volatility. As Table 5 indicates, the relationship between the two is quite weak. While d, is largest in absolute value in 1973, the year of greatest exchange rate instability, and declines along with growing stability in exchange rates to 1975, the increase in d3 from 1976 to 1977 and the comparison between the values of d, in 1975 and 1977 are inconsistent with movements in exchange rate

275


instability between those years. Consequently there appears to be no strong relationship between expost exchange rate instability and the perceived effects of exchange rate instability on the volume of trade.

Table 5

Values of d3 and Indices of Exchange Rate Variability

Year 1972 1973 1974 1975 1976 1977

d3 - - 1.247 - 0.594 - 0.309" - 0.729 - 0.851 M-M Neerb 0.53 1.67 1.37 0.94 1.28 0.83 M-M Reerc 0.56 1.79 1.50 1.02 1.16 0.87 Q-Q Neerd 1.16 3.49 2.74 2.14 2.85 1.60

M-M Beer' 0.68 3.40 1.90 1.22 3.98 1.16 Q-Q Reere 1.68 3.65 2.85 2.50 2.29 1.49

Notes: /a Value not statistically significant from zero. /b Major industrial countries: average month-to-month percentage changes in

/c Major industrial countries: average month-to-month percentage changes in real

/d Major industrial countries: average quarter-to-quarter percentage changes in

/e Major industrial countries: average quarter-to-quarter percentage changes in

/f Major industrial countries: weighted average of monthly variability of bilateral

nominal effective exchange rates, weighted according to current trade shares.

effective exchange rates, weighted according to current trade shares.

nominal effective exchange rates, weighted according to current trade shares.

real effective exchange rates, weighted according to current trade shares.

nominal exchange rates.

Source: Table 3 and IMF [1984a, pp. 38-42].

IV. CONCLUSIONS

In this paper we have examined the effect of exchange rate regimes on the volume of international trade. We find that bilateral trade flows among countries with the floating exchange rates are higher than those among countries with fixed rates. While exchange rate uncer- 276


tainty does lower the volume of trade among countries, regardless of the nature of their exchange rate regimes, its effects are less than the trade-reducing effects of restrictive commercial policies imposed by fixed exchange rate countries.

DATA APPENDIX

Variable Units of measurement and how constructed

Xij = volume of exports from country i to country j, measured in millions of U. S. dollars and calculated by dividing export values obtained from United Nations, International Trade Yearbook, various years, by the export unit value index (1975 = 100) for country i obtained from IMF International Financial Statistics, line 74. income in the exporting (importing) country, measured in millions of U.S. dollars and calculated by dividing gross domestic product of the exporting (importing) country obtained from various issues of U. N. National Income Statistics, IMF International Financial Statistics, or World Bank, World Bank Tables, by the consumer price index (1975 = 100) for the exporting (importing) country obtained from IMF International Financial Statistics, line 64. The latter was used for consis- tency since the GDP implicit price deflator was not available for many developing countries. population in the exporting (importing) country, measured in millions of persons at mid-year, from U. N. Demographic Yearbook, various issues. distance between countries i and j, measured in statute miles from R. W. CAREY and J. R. REYNOLDS, Reed’s Marine Distance Tables, Lon- don: T Reed, 1978.

Yi(j) =

Ni(j) =

Dij =

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WILLETT, T. D.: Floating Exchange Rates and International Monetary Reform, American Enterprise Institute Studies in Economic Policy, Washington, D. C.: American Enterprise Institute for Public Policy Research, 1977.

SUMMARY

This paper examines the effects of exchange rate variability on the volume of bilateral trade. Our approach differs from previous work in two ways. First, it infers the effect of exchange risk without the use of proxies such as ex post exchange rate variability. Second, it quantifies not only the effects of the exchange risk on trade, but also the effect of exchange rate regime on commercial policy and ultimately on trade. We find that risk is greater, and trade lower, ceteris paribus, in trade between two countries whose currencies are not fixed against each other. Nevertheless, floating rates lead to a higher volume of trade because the effects of exchange risk on trade are less than the effects of the restrictive commercial policies that accompany fixed rate regimes.

ZUSAMMENFASSUNG

Der Artikel untersucht die Wirkungen von Wechselkursschwankungen auf das bilaterale Handelsvolumen. Dabei unterscheidet sich der Ansatz von vorangegange- nen Untersuchungen in zwei Punkten. Erstens schliesst er auf die Wirkung von Wahrungsrisiken ohne Verwendung stellvertretender Grossen, wie ex-post-Wechsel- kursschwankungen, und zweitens quantifiziert er nicht nur die Auswirkungen des

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Wahrungsrisikos auf den Handel, sondern auch diejenigen des Wechselkurssystems auf die Handelspolitik und somit letztendlich auf den Handel selbst. Zwar ist dieser zwischen zwei Landern ohne fixe Wahrung ceteris paribus geringer und das Risiko hoher. Dennoch fiihren flexible Wechselkurse zu einem hoheren Handelsvolumen, weil sich das Wahrungsrisiko auf den Handel weniger auswirkt als eine restriktive Handelspolitik, welche eine Begleiterscheinung fester Wechselkurssysteme ist.

Cet article examine l’effet de la variabilite des taux de change sur le volume du commerce bilateral. Notre approche differe de deux faGons des travaux precedents. Elle induit, tout d’abord, l’effet du risque de change sans utiliser des representations telles que la variabilite des taux de change ex post. En second lieu, elle quantifie non seule- ment les effets du risque de change sur le commerce mais egalement I’effet du regime de taux de change sur la politique commerciale et, injine, sur le commerce. Toutes choses egales par ailleurs, nous trouvons que le risque est plus grand, et le commerce plus faible, lorsque les pays qui echangent ont des devises dont le taux n’est pas fixe entre elles. Toutefois, les taux flottants conduisent a un volume commercial plus eleve car les effets du risque de change sur le commerce international sont moindres que les effets des politiques commerciales restrictives qui accompagnent les regimes de taux de change fixes.

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Exchange Rate Risk, Exchange Rate Regime and the Volume of International Trade

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