The resource reallocation costs of fixed and flexible exchange rates

THE RESOURCE REALLOCATION COSTS OF FIXED AND FLEXIBLE EXCHANGE RATES A multi-country extension

Marie THURSBY Ohio State University,

Columbus, OH 43210. USA

Received March 1981, revised version received April 1981 For a sample of nineteen countries for 1972-79 we test the hypothesis that reallocation costs associated with temporary disturbances to the export sector of an economy are equal under fixed and flexible exchange rates. This test is an extension of earlier work indicating that in the special! case of Canada, reallocation costs do not differ significantly under fixed and flexible rates. The degree of industrialization and openness of the countries included in the sample varies greatly; so it is interesting that the Canadian result generalizes to all but two cases. These results suggest that even during periods of considerable exchange rate variability, unnecessary resource reallocation costs may not be a significant disadvantage of a flexible exchange-rate system.

This paper extends the author’s earlier analysis of Canadian resource reallocation costs to a sample of nineteen countries for 1972-79. Using the measures of reallocation costs developed in Thursby (1980), we test the hypothesis that reallocation costs of fixed and flexible exchange rates do not difier significantly.’ These results are interesting since the Canadian result generalizes to all but two cases for a sample of countries which differ greatly in clegrees of both openness and industrialization. The reader is referred to Thursby for a justification of this method. We test the null hypothesis c ==O,where

(1) where x(t) is the quantity of exports and &u(t) is defined in absolute value terms. As shown in Thursby (198(I), under fairly simple assumptions reallocation in response to export related disturbances is directly related to changes in exports, so that we can interpret c >O (c ~0) as export-related ‘The costs of resource transfer are the output foregone while resources are transferrled plus the hiring and training costs during the transfer. Cqr our purposes we want measures of these costs incurred as a result of reversible or temporary disturbances to the trade sector, holding constant the aggregate level of employment.

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North-Holland

reallocation cost:; under a tIexit&: rate being grester (less) than those under a Fixedrate, cuter&sparibus. For 1972--79 data for x&k, are available ffrorn standard sources, and x(t)f

is generated by

where e& and e,, are the dwand

and suplply elasticities for exports,

respectively, and

where r(t) is the domestic currency price of forczignexchange. To examine whether c=O because firms adjaist slowly to profit changes or whether signals for reakcation are no different with the flexible and fixl=d exchange rates, we test the hypothesis g= 0, where E is the mean difference of fluctuations in the valrue of exports under a flexible rate and the hypothetical fixed~rate r(l k. That is,

(3) where X (t 9is the: value of expotts. X (t)Yis generated bjy

(4) where e,, e,, and - P, are Wined above. Assuming that exporters use only domestic inputs EOj implies that eKpor: profits vay less (more) under the flexible rate than under the hypothetic.ai f&d rate, ceieris putibus.

Tables I :nd 2 gke estimates of c and E based on quarterly bata’ for 1972-79. FG; both tests, the hypothetical fixed exchange rate, r(t)bY3is the arithmetii aean of the acrua.l fluctuating exchange rate, Data For X(t) are quarterly values of exports denominate8 in wits of local currency :inci data for x(t) are values of export; divided by export price indices. We report results for va.lue~ of e, and e,, which range from 0.5 to 1.5. ‘Alldafa aw t&en RiomInterw#Co&Financial Srat?stics. Except where noted e:xportdata are dcnomiaatrd in bi&ons of units of domestic current-y. Price indicts and e!kctive exchange rater have the base l!JTS= lo@. “& in Thussby ~[I!%@, the rigidly Bxed rate assumed for r(tr, causef. this test KOdiffer fuom a compwkm with the betton Woods :rystem. %?te that country di!Terences in magnitudes of C a?e not mtw~ingf’ul becawe data are measured in local cwrency units.

M. ThursSy, Resource reallocationCOSIS

489

For eight countries e>O, but in none of these cases can we reject the null hypothesis (at 5 percent) that quarterly fluctuation in the quantity of exports is unaffected by exchange rate variability, ceteris paribux4 For the eleven countries where c *COthe difference in export fluctuation is significant in only two cases. For Ireland c is significantly less than zero for ed,l 1.0 and e,, 11.0, and e for Italy is significantly less than zero only for edX= 1.5 and e = 1.5. Thus, in the majority of cases we fail to reject the null hypothesis C ZO. AS shown in table 2, these results are consistent with our results for E. For ten countries E>O, which under our assumptions implies that flexible rates signaled more resource reallocation than would a fixed rate during the same period. However, the difference in signals was insignificant at the 5 percent level in all cases. For the remaining nine countries EcO, and for four of these E was significantly different from zero. E for Ireland and Italy is significantly less than zero for all elasticity values. This is the expected result since for these two countries is < 0 for sufficiently high elasticity values. Note, however, that for e& < 1 and for e&u- 1 and e,, =O.S we cannot reject e = 0 at the 5 percent level for Ireland even though EcO for those values. Similarly, in the case of Italy, for e& < 1.5 and for ed, = 1.5 and e,, < 1.5, c =0 cannot be rejected. E is also significantly less than zero for ed,,,2 1 in the cases of Japan and the United Kingdom, but if is not significantly less than zero for any elasticity values in either case. In summary, these results suggest that the Canadian experience during the seventies was not a counterexample. The majority of our cases suggest that signals for resource reallocation into and out of export sectors were ho greater than if the exchange rate had been pegged at the mean of the actual exchange rate. Moreover, where signals were significantly different for the actual and simulated systems our results are consistent with slow adjustment on the part of exporting firms so that c#O only for sufficiently high values of ed, and e,,,. It is interesting that in no case do we find the flexible rate to have caused significantly higher reallocation cost than the hypothetical fixed rate. 5$lote that Thursby (1980) also presented results of a slightly differentprocedure for the sixties, i.e. a comparison of expo& fluctuation with that under a simulated flexible rate. Such simulations were not done for this study because of data availability. The procedure for the sixties requires balance of payments data which are not available quarterly for the entire sample of countries.

Reference Tlzursby, M., 19’80,The Iresourcereallocation costs of fixed and flexible exchange rates, Journal of International Economics 10, 79-90.

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