A Faith-Based Initiative Meets the Evidence: Does a Flexible Exchange Rate Regime Really Facilitate Current Account Adjustment?

It is often asserted that a flexible exchange rate regime would facilitate current account adjustment. Using data on over 170 countries over the 1971–2005 period, we examine this assertion systematically. We find no strong, robust, or monotonic relationship between exchange rate regime flexibility and the rate of current account reversion, even after accounting for the degree of economic development and trade and capital account openness. This finding presents a challenge to the Friedman (1953) hypothesis and a popular policy recommendation by international financial institutions.