Study Examines Exchange Rate Changes and Impact on APEC Trade and Investment

• Pages: 37-38

Page 37

The 18 members from Asia and the Western Hemisphere that form the Asia-Pacific Cooperation Council (APEC) include many of the world's fastest growing economies over the past decade. APEC, which also includes the United States and Japan, offers a valuable sample against which to test the link-exemplified by Japan's experience-between rapid output growth and exchange rate appreciation and to examine the influence that exchange rate fluctuations exert on trade and investment decisions.

A recent IMF Economic Forum, based on IMF Occasional Paper No. 145, Exchange Rate Movements and Their Impact on Trade and Investment in the APEC Region, analyzed APEC's experience. Takatoshi Ito and Peter Isard of the IMF's Research Department and Tamim Bayoumi of the IMF's Asia and Pacific Department analyzed comparative data from the region and reviewed the relevant literature. They found several instances in which the rapidly growing APEC economies did not follow the Japanese example of real exchange rate appreciation in association with rapid growth. Their findings did, however, support the widely held views that medium-term movements in exchange rate levels have clear and important implications for trade volumes and that exchange rate changes appear to influence foreign direct investment decisions.

Growth and Exchange Rates

Long-term changes in nominal exchange rates are often explained to a significant extent by inflation differentials. More resistant to ready explanation have been the long-term movements in real exchange rates, defined as nominal exchange rates adjusted by differences in national inflation rates. One theory- advanced by Bela Balassa and Paul Samuelson in the 1960s-posits that relatively rapid output growth tends to be associated with more rapid productivity growth in the tradable goods sectors than in the nontradables sectors, which thus puts upward pressure on the price of nontradables relative to that of tradables. If the relative price of tradable goods remains approximately constant across countries, the Balassa-Samuelson hypothesis argues, a rise in the relative price of nontradables will lead to real exchange rate appreciation.

This was Japan's experience in the high-growth phase of its economic development. The IMF study queries whether this has been the norm for other APEC members that have experienced high growth. The...