Does the exchange rate regime influence the relationship between the output gap and the current account?

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Abstract:

Estimates of the output gap are useful for identifying the sustainable level of noninflationary output growth in countries with a flexible exchange rate regime. For nations with a fixed exchange rate, however, domestic prices are inexorably linked to the prices of its main trading partners and are unlikely to bear little relation to the output gap. This article uses data on 45 developed and developing countries between 1970 and 2004 to show that a positive output gap in a country with a fixed exchange rate is more liable to be reflected in an imbalance on the external current account.

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036840600707035

Affiliations: 1: Research Department, Central Bank of Barbados, Bridgetown, Barbados 2: Department of Economics, University of the West Indies, Bridgetown, Barbados

Publication date: August 1, 2007

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