The relationship between exchange rates and International Trade: a review of economic literature

This paper surveys a wide body of economic literature on the relationship between currencies and trade. Specifically, two main issues are investigated: the impact on international trade of exchange rate volatility and of currency misalignments.

On average, exchange rate volatility has a negative (even if not large) impact on trade flows. The extent of this effect depends on a number of factors, including the existence of hedging instruments, the structure of production (e.g. the prevalence of small firms), and the degree of economic integration across countries. Exchange rate misalignments are predicted to have short-run effects in models with price rigidities, but the exact impact depends on a number of features, such as the pricing strategy of firms engaging in international trade and the importance of global production networks. This effect is predicted to disappear in the long-run, unless some other distortion characterizes the economy. Empirical results confirm that short-run effects can exist, but their size and persistence over time are not consistent across different studies.

No: ERSD-2011-17


Marc Auboin and Michel Ruta

Manuscript date: October 2011

Key Words:

Exchange rates, volatility, misalignments, international trade

JEL classification numbers:

F10, F31, F55, O19, G21, G32

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This is a working paper, and hence it represents research in progress. This paper represents the opinions of the author, and is the product of professional research. It is not meant to represent the position or opinions of the WTO or its Members, nor the official position of any staff members. Any errors are the fault of the author. Copies of working papers can be requested from the divisional secretariat by writing to: Economic Research and Statistics Division, World Trade Organization, Rue de Lausanne 154, CH 1211 Geneva 21, Switzerland. Please request papers by number and title.

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