Empirical Framework, Data, and Stylized Facts

: This paper assesses the stabilization properties of fixed versus flexible exchange rate regimes and aims to answer this research question: Does greater exchange rate flexibility help an economy’s adjustment to weather shocks? To address this question, the impact of weather shocks on real per capita GDP growth is quantified under the two alternative exchange rate regimes. We find that although weather shocks are generally detrimental to per capita income growth, the impact is less severe under flexible exchange rate regimes. Moreover, the medium-term adverse growth impact of a 1 degree Celsius increase in temperature under a pegged regime is about –1.4 percentage points on average, while under a flexible regime, the impact is less than one half that amount (–0.6 percentage point). This finding bolsters the idea that exchange rate flexibility not only helps mitigate the initial impact of the shock but also promotes a faster recovery. In terms of mechanisms, our findings suggest that the depreciation of the nominal exchange rate under a flexible regime supports real export growth. In contrast to standard theoretical predictions, we find that countercyclical fiscal policy may not be effective under pegged regimes amid high debt, highlighting the importance of the policy mix and precautionary (fiscal) buffers. This paper empirically assesses contrasting theoretical predictions about the macroeconomic stabilization properties of fixed and flexible exchange rate regimes by quantifying the impact of weather shocks on per capital real GDP growth. The weather shocks are computed as annual variations in temperature and precipitation. Although climate change has been attributed to human activity (IPCC, 2021), weather shocks are unpredictable and not directly caused by economic decisions, especially those relating to exchange rate policy. To quote a saying attributed to Mark Twain: “Climate is what we expect, weather is what we get. ” The results of the paper provide broad support for the notion that greater exchange rate flexibility can help emerging developing countries better adjust to shocks. In particular, fixed exchange rate regimes perform considerably worse when weather shocks occur relative to flexible regimes, on average. For a 1 degree Celsius increase in would real per capita by points upon impact under peg, the non-pegged exchange rate regime be percentage point. while the medium-term adverse growth impact the peg about percentage points on average, under the flexible regimes, this impact is less than one half that amount (–0.6)—and not statistically significant. In other words, greater exchange rate flexibility not only helps mitigate the initial impact of the shock, but also promotes a faster recovery. The underlying adjustment mechanism also seems to be generally consistent with that identified in the standard theoretical The medium-term increase in real export growth 1.4 percentage points under flexible exchange rate regimes compared to 5.5 percentage point decline under the pegs. consistent with the adjustment a depreciation of the nominal exchange there is a significant export response for non-pegged a countercyclical fiscal policy stance in high debt