CFCM 19/07: Foreign exchange inflows, the trade balance and real effective exchange rates

Summary

There has long been a concern that large net inflows of property income or income transfers (such as aid and remittances) pull up the real exchange rate and thus divert resources away from the tradables sector (the so-called Dutch disease effect), although the empirical evidence is somewhat mixed. Using annual data for a large sample of countries back to 1971, it is shown here that the long-run effect of an improvement in the non-trade elements of the current account balance is real exchange rate appreciation and a deterioration of the trade balance.

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A revised version of this discussion paper was published in Open Economies Review, Vol. 31, No. 4 (September 2020), pp. 881-900.

Authors

Michael Bleaney and Mo Tian

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