There was one post yesterday, “Real Exchange Rates and European Adjustment:”
Still in Lisbon, although heading home soon. And I found myself wondering about an empirical question: what would a crude look at the correlation between real exchange rates and trade adjustment look like?
The reason I raise this question is that I keep hearing forms of elasticity pessimism – assertions that internal devaluation either hasn’t worked or isn’t necessary, that there’s no real correlation between doing well on exports and reducing relative prices or unit labor costs. But are these assertions true? What are the stylized facts?
Well, here’s a quick and dirty look. I take as my independent variable the change in the real effective exchange rate from 2008 to 2015, taken from the European Commission database. I take as my dependent variable the change in the current account as a percentage of GDP, also from 2008 to 2015, from the IMF World Economic Outlook database. Here’s what you get:
Er, the stylized fact seems to be a quite strong correlation between real exchange rates and trade adjustment.
OK, I’m aware that this is too crude to be interpreted as a causal relationship – at least some and maybe most of the adjustment we see is the result of import compression, driven by austerity-driven downturns, rather than improved competitiveness. But it’s still somewhat startling how different the data are from the widespread impression.
So where did the impression come from? One thought: we tend to look at real exchange rates of peripheral economies vis-à-vis the European core, which would be sufficient if the euro exchange rate hadn’t moved much and/or if euro countries were equally affected by euro depreciation. In fact, however, the euro has fallen a lot, and this has very differential effects: it’s a big gain for countries like Ireland that do a lot of their trade with non-euro (and non-European) partners, much less for countries like Greece that are more locally focused.
In any case, the raw correlation between real exchange rates and trade adjustment is much stronger than I thought, and probably than most people think.