Coping with Terms of Trade Shocks: Pegs versus Floats

The choice of the exchange-rate regime has always been an area of great controversy and debate. The discussion has once again taken center stage in the developing world. The sequence of currency crises in the 1990's, the success of culTency-board arrangements, the dollarization plan of Ecuador, and the apparent swing toward flexible regimes of many emerging economies has revived interest in this debate. Milton Friedman (1953) argued that one of the most important advantages of flexible regimes over fixed regimes is that they can smooth adjustment to real shocks even in the presence of nominal rigidities. Ever since, this has been one of the least disputed benefits attributed to fully flexible exchange-rate regimes. Subsequent to Friedman, many theories of the international transmission of real shocks have confirmed the original intuition that the shortrun responses to terms-of-trade shocks should be different across exchange-rate regimes. Here I look at a post-Bretton Woods sample of 74 developing countries to test whether flexible regimes can buffer terms-of-trade shocks better than fixed regimes.