Current Account and Real Exchange Rate changes: the Impact of Trade Openness

In the transfer problem debate with Keynes, Ohlin suggests that income eects should lessen relative price variations necessary to pro- duce trade surpluses, and that that impact is related to the degree of openness of the economy. We illustrate this mechanism in a sim- ple model, and take it to the data. First, using data for developed and emerging economies for the period 1970{2011, we identify events of sudden stops of capital ows and of abrupt real exchange rate de- preciations. Then, we investigate the relationship between openness to trade, real exchange rate depreciations, and changes in current account and trade balances during these events. We nd that, controlling for real exchange rate changes, more open economies experience a larger increase in current account and trade balances. In other words, our results indicate that improvements in current account and trade bal- ances are accompanied by a smaller real exchange rate depreciation in more open economies.