The changing role of the exchange rate for macroeconomic adjustment

Recent episodes of large exchange rate movements, such as for Japan or the United Kingdom, have typically not been associated with large changes in trade balances and despite the polarisation of international investment positions large currency fluctuations during the global crisis of 2008-09 did not cause significant financial dislocations. This paper presents empirical evidence that for a number of OECD countries firms’ increasing participation in global value chains may have contributed to reducing exchange rate pass-through to the terms of trade, which may in turn have contributed to reducing the response of trade balances to exchange rate changes. Further empirical evidence suggests that over the past two decades large net external debtor countries, including emerging market economies, have reduced net aggregate foreign currency exposures, thereby limiting direct financial effects of exchange rate fluctuations through the valuation of external assets and liabilities. However, sizable increases in foreign currency borrowing for a number of emerging market economies in the wake of the global crisis of 2008-09, including by non-financial corporations, suggest that large exchange rate movements may nonetheless cause financial stress for exposed sectors and entities that may percolate through the financial system despite limited aggregate exposures.