The Shock-Absorbing Capacity of the Flexible Exchange Rate in Poland

Since the highly influential paper of Meese and Rogoff (1983), who pointed out that the behavior of nominal exchange rates (NERs) can be described by a simple random walk, a lot of ink has been spilled over the sources of NER fluctuations in the context of the exchange rate regime choice. The empirically observed large NER volatility under floating led many to perceive the flexible NER as a source of shocks (Buiter, 2000; Buiter and Grafe, 2002; Mundell, 2003). In contrast, analyses drawing on the theory of optimum currency areas, which was initiated by the works of Mundell (1961) and McKinnon (1963), are based on the notion that the (irrevocable) fixing of the NER represents a cost to the economy in terms of macroeconomic stability because, due to nominal rigidities, the real exchange rate (RER) reacts to asymmetric shocks more slowly than under floating. The consensus view seems to be that the flexible NER can act as a shock-absorbing instrument in the case of some shock types and as a shock-propagating instrument in the case of other shock types. Specifically, the NER is thought of as a stabilizing instrument if its fluctuations are mainly driven by real, especially demand, shocks and as a destabilizing one if they are largely driven by nominal disturbances (see section 2). Using this implicit assumption, many authors have studied the sources of NER and RER fluctuations within the Structural Vector Autoregressive (SVAR) model with long-run identifying restrictions à la Blanchard and Quah (1989). The first such paper was by Lastrapes (1992); other authors, most notably Clarida and Galí (1994), have modified his model to include additional variables and shock types. The results of this strain of literature are briefly reviewed in section 2. This paper contributes to the empirical literature analyzing the sources of NER and RER fluctuations. The focus is on Poland roughly over the recent decade. As a (relatively) new Member State of the European Union (EU), Poland is obliged