Current account imbalances, the EU case and the US one. The importance of exchange rate pass-through in determining tradables price fluctuations

1. Global imbalances, trade
openness and exchange rate
pass-through
1
Giuseppe Caivano - PhD Candidate Università degli Studi di Bari
Bari, 11 December 2014

2. Outline of the presentation
• Current Account Imbalances in the EU: the role of trade
openness
• Current Account Rebalancing and Exchange Rate Adjustment in
the United States
• Estimating pass-through for EU countries: do potential
asymmetries play a role?
2

3. Current Account Imbalances in the EU: the
role of trade openness
SOME STYLIZED FACTS:
 Since mid-2000s, most of the academic debate was focused on the
United States - where current account deficits continuously deepened-and,
on China which kept running substantial current account
surpluses.
 The EU kept for a long period a substantial balance as a whole.
However, recently many states are experiencing growing imbalances.
Surplus: Germany, Sweden, Netherlands
Deficit: Greece, Spain, Portugal
3

4. Current account balance in selected European countries
Source: authors’ elaboration on Eurostat Data
 Commercial imbalances softened after the outbreak of the global
crisis of 2008-09 but still remained considerably high
4

5.  Another pattern of divergence is associated with the recent
sovereign debt crisis that is affecting EU member States. The fiscal
positions of the EU periphery has worsened considerably more than in
the rest of EU countries
180
160
140
120
100
80
60
40
20
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Debt/GDP
35
30
25
20
15
10
5
0
-5
-10
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Germany Ireland Greece Spain France Italy Portugal
2012
2013
Deficit/GDP
Core-Periphery: the heterogeneous worsening of fiscal conditions in selected European
countries. Source: authors’ elaboration on Eurostat Data 5

6. Introduction
• The goal of the paper is to investigate, employing panel
cointegration technique, the long-run drivers of current account
imbalances in 15 EU member States
• Our results indicate that competitiveness factors strongly affect
imbalances in countries with a low trade openness, while the
effects weakens as trade openness increases
• High income countries tend to run surpluses, low-income ones
accumulate deficits (convergence hypothesis)
• Credit sector plays an increasing role after the introduction of the
common currency-> more integrated financial markets give easier
access to credit for countries that need to finance possible trade
deficits.
6

7. Potential drivers of the imbalances
Long-run dynamics of CA imbalances attracted an increasing attention
in the literature (Clarida, 2006; Obstfeld and Rogoff, 1996). Potential
determinants of imbalances can be grouped as follows:
i. The income (or convergence) channel and the role of financial
flows: increasing financial integration weakens the connection
between internal investment and savings (Feldstein and Horioka,
1980).
With integrated markets, lower income countries can borrow
more in order to converge towards high income one (Blanchard
and Giavazzi 2002, Lane and Pels 2012, Ahearne et al. 2007)
7

8. Potential drivers of the imbalances
ii. The competitiveness channel: A higher real exchange rate makes
tradable goods more expensive with respect to foreign goods
Arghyrou and Chortareas (2008) , Blanchard (2007), Belke and
Dreger (2013).
The pattern documented by these authors is not in line with the
convergence hypothesis, as they argue real exchange rate to be
the most important driver of CA fluctuations
iii. Fiscal policy and government debt: Higher debt and expansionary
fiscal policy can translate into lower domestic savings and
contribute to lower CA balance (Feldstein, 1987).
Ricardian equivalence argument criticize this hypothesis.
8

9. Potential drivers of the imbalances
Mixed results from empirical studies: Abell (1990), Frankel (2006)
and Abbas et al. (2010) in support of these hypothesis
Roubini (2006) and Kim and Roubini (2008) find on the contrary
that as fiscal deficits grow, CA balance improves
Other authors (Blanchard, 2007b and Edwards, 2005) argues the
fiscal channel to be insignificant or, at best, secondary in
explaining CA behavior
9

10. Potential drivers of the imbalances
In the EU context, literature is quite scarce. Belke and Dreger
(2013) find a negative correlation between debt and CA balance
for southern EU while Aristovnik and Djuric (2010) find a weak
correlation and therefore reject the twin deficit hypothesis.
iv. Demographic factors: Countries with a higher old-age
dependency ratio can have different saving/investment behavior.
Chinn et al. (2003) find a negative impact of dependency ratios on
CA balance.
10

11. The role of trade openness
Theoretical models show how higher trade openness improves the
economy’s ability to reorganize production in case of adverse shifts in
unit labour productivity and relative prices (Cox 2007, Neary 2009 and
Navas and Licandro 2010)
With higher openness, firms face higher competition both in home and
foreign markets. Therefore, firms are pushed to improve their cost
structure and to be more productive to stay in the market (Chen et al.
2009)
As international firms are generally more efficient than purely
domestic ones (Melitz and Ottaviano 2008, Mayer et al. 2001), we
expect than more open economies are more able to face adverse
changes in real exchange rate (i.e. rer channel has a smaller impact)
11

12. The role of trade openness
Moreover, as openness is strictly correlated with international capital
integration, the effect of this channel might be heterogeneous
according to the level of openness.
More open economies are likely to have (ceteris paribus) better access
to international capital markets. In this economies a bigger credit
sector is associated with better CA balance (Russ and Valderrama,
2009)
Similarly, also fiscal channel can behave differently according to
different degree of openness (i.e. we expect it to be stronger for low-openness
countries)
12

13. Data and estimation technique
Variable name Description Source
ca Current account balance (% GDP) European
Commission –
AMECO database
rer Real effective exchange rate (unit labor costs, in
log)
Bank of International
Settlements
y Real GDP per capita (in log) AMECO
debt Total government debt (% of GDP, in log) AMECO
dep Old-age dependency ratio (% of working age
population, in log)
AMECO
cred Total domestic credit provided by the banking
sector (% of GDP, in log)
IMF – International
Financial Statistics
Database
Countries : Austria, Denmark, Belgium and Luxembourg, Finland, France, Germany,
Greece, Ireland, Italy, Netherlands, Portugal, Spain, Sweden, United Kingdom. Period:
1974-2011
13

14. Data and estimation technique
Given the presence of stochastic trends, panel cointegration methods
are used. Panels allow to fully exploit cross-section and time series
dimension.
PANEL UNIT ROOT TESTING:
CADF test (Cross-sectionally Augmented Dickey Fuller test)
by Pesaran (2007): this test has the advantage to control for cross
section dependencies in heterogenous panels. The usual ADF test is
augmented with cross-section average of the lagged levels and first
differences of the individual series.
If null is rejected, at least one panel member is stationary.
14

15. Data and estimation technique
PANEL COINTEGRATION TESTING:
To examine cointegration, panel and group mean statistics suggested
by Westerlund (2007) are applied.
The principle is to evaluate the null hypothesis of no cointegration by
inferring whether the feedback parameter in a panel error-correction
model is equal to zero. In particular, statistics are computed as:
Where αi is the feedback
parameter.
15

16. Data and estimation technique
If null is rejected, cointegration holds for all units in case of the panel
statistics and at least for one individual in the group statistics.
The tests behave asymptotically as standard normal. However, because
cross-section are not independent, critical values are obtained by
bootstrap methods (800 replications).
16

17. Data and estimation technique
Finally, we estimate the cointegration vector by using the Pesaran et al.
(1999) Pooled Mean Group (PMG) estimator
• This allows to constrain long-run components to be the same across
group, relaxing this assumption in the short-run.
• This estimator can be used independently from the integration order
of the variables of interests
• Assuming the long-run homogeneity increases the efficiency
(provided this hypothesis is true)
•As a robustness check, a comparison with the more general Mean
Group (MG) estimator is done by running a Hausmann test
17

18. Estimation results and inference
The (long-run) empirical equation on the determinants of current
account (im)balances is the following:
0 1 2 3 4 5
cait i  yit  rerit  debtit  depit  credit  it
0
i 
(1)
where is a country-specific effect, i is the country index and t is
the time period. Given the high correlation of dependency ratio
with the debt and cred variables, our preferred model specification
is:
0 1 2 3 4
it i it it it it it ca   y  rer  debt  cred   (2)
18

19. Summary statistics of the variables employed
Variable Obs Mean Std. Dev. Min Max
rer 532 4.588 0.133 4.236 5.098
ca 532 -0.012 0.066 -.499 .155
debt 532 3.930 0.560 1.816 5.138
dep 532 3.095 0.155 2.728 3.476
y 532 5.325 0.359 4.172 6.016
cred 532 4.251 0.542 2.899 5.447
19
We use Annual data from 1974 to 2013. Trade openness is intended as total exports and imports
to GDP ratio. Openness data by country: Austria (107.2), Belgium (172.0), Denmark (98.6), Finland
(84.2), France (54.7), Germany (83.6), Greece (44.3), Ireland (148.4), Italy (55.8), Luxembourg
(285.2), Netherlands (133.5), Portugal (70.7), United Kingdom (57.7), Spain (59.1), Sweden (94.6)

20. Estimation results and inference
Integration tests for the variables employed in the analysis (levels and first differences. Pesaran
(2007)’ methodology)
Variable Model specification
includes:
Levels First Differences
ca constant
constant and trend
-0.256 (0.399)
0.175 (0.569)
-5.795 (0.000)***
-4.342 (0.000)***
y constant
constant and trend
-2.557 (0.005)***
-0.303 (0.381)
-7.592 (0.000)***
-8.780 (0.000)***
rer constant
constant and trend
-1.583 (0.057)*
-3.069 (0.001)***
-10.443 (0.000)***
-8.818 (0.000)***
debt constant
constant and trend
-1.018 (0.154)
-1.081 (0.140)
-3.021 (0.001)***
-2.343 (0.010)***
dep constant
constant and trend
1.160 (0.877)
4.171 (1.000)
-1.858 (0.032)**
1.071 (0.858)
cred constant
constant and trend
-0.877 (0.190)
0.358 (0.640)
-5.885 (0.000)***
-5.002 (0.000)***
P-values in parenthesis. ***, ** and * are intended as 1%, 5% and 10% confidence level.
20

21. Estimation results and inference
Group mean and panel cointegration tests (Westerlund, 2007)
Variables Gτ Gα Pτ Pα
ca, y, rer, dep,
debt
-4.616***
(0.000)
1.057
(0.204)
-4.697***
(0.008)
-1.807*
(0.048)
ca, y, rer, cred,
debt
-4.099***
(0.000)
1.608
(0.396)
-5.974***
(0.000)
-1.438*
(0.083)
ca, y, rer, cred,
dep
-4.236***
(0.000)
1.015
(0.189)
-6.036***
(0.004)
-1.050
(0.136)
ca, y, rer, cred,
dep, debt
-4.133***
(0.001)
2.140
(0.408)
-5.216***
(0.010)
0.054
(0.231)
Critical values obtained using bootstrap with 800 replications. P-values in parenthesis. ***, ** and * are
intended as 1%, 5% and 10% confidence level. Lag and lead length chosen with AIC selection criterion.
Cointegration is assumed to hold if the null is rejected for all units in the case of the panel statistics, and at
least for one member in the case of the group mean statistics. The tests are asymptotically normal
distributed, and can account for individual short-run dynamics, trend and slope parameters.
21

22. Estimation of the cointegration vector (total sample)
Dependent
variable: ca
Coefficients
rer -.2972***
(.0426)
y -.0217
(.0343)
debt .0558***
(.0138)
cred -.0193*
(.0115)
Hausmann test
Prob >Wald chi2
0.8353
Sample period: 1974-2011. Standard errors in
parenthesis. ***, ** and * are intended as 1%,
5% and 10% confidence level.
 Real exchange rate is the most
important determinant of CA imbalances
Income channel appears to be absent
 Government debt has a small but
positive effect on trade balance (in
contrast with the twin deficit hypothesis)
 Credit impact very small and
significant only at 10% level.
22

23. Does trade openness matter?
To our knowledge, the analysis on the role played by trade openness
((exp+imp)/GDP) has not been performed in previous studies.
Here we split the sample in three sub-groups on the basis of trade
openness indicator computed using WTO trade statistics :
 Low-openness -> France, Greece, Italy, Spain, UK and Portugal
(<70% GDP)
 Medium-openness -> Denmark, Finland, Germany and Sweden
(from 80% to 110% GDP)
 High-openness -> Austria, Belgium/Luxembourg, Ireland,
Netherlands (>130% GDP)
Results don’t change significantly if we slightly change the composition of the
groups
23

24. Does trade openness matter?
Dependent
variable: ca
High
openness
Medium
openness
Low
openness
rer -.0691*
(.0361)
-.18667*
(.1063)
-.4368***
(.1082)
y -.0546***
(.0207)
-.25981
(.1790)
.10709*
(.05764)
debt .0229***
(.0075)
-.0421***
(.0099)
-.0560***
(.0186)
cred .0343***
(.0083)
.08716*
(.0500)
-.0865***
(.0209)
All regressions include a country-specific constant. Standard errors in parenthesis. ***, **
and * are intended as 1%, 5% and 10% confidence level.
RER impact increases
as openness decreases
Countries with a small
tradable sector are
more sensitive to
competitiveness
changes
More open economies can better reorganize production in case of adverse
shift in ULC (Cox 2007, Neary 2009 and Navas and Licandro 2010)
- Productivity factors (Chen et al. 2009)
- Market structure factors: low openness countries exports more
concentrated in goods where price setting is more constrained and firms
can’t adjust their mark-up
24

25. Asymmetric effects of CA determinants
 Income variable significant (but negative) for high-openness
countries: higher gdp is associated with a worse CA position. The
opposite is true for low-openness States.
 Higher debt/gdp ratio associated with higher CA deficits in the less
open countries
Credit sector negatively correlated with CA balance in low-openness
group; on the contrary, is positively correlated in the high-openness
one
25

26. Possible explanations
Rise of emerging economies interactions on EU States:
 Capital inflows from emerging economies concentrated on EU core countries
 Core countries outflows to periphery financed their CA deficits (Chen et al.
2013)
 China and Eastern EU states increased competition mostly on EU periphery
(with a low trade openness) (Chen et al. 2013, Di Mauro et al. 2000) while they
have been beneficial for Germany and Austria’s exports (Marin, 2010)
 These interactions cannot be captured in our regression and can potentially
explain the insignificance of some coefficient in the medium openness cluster
Different wealth effects and different possibility to access to credit
markets can explain the asymmetric credit and debt impact.
 In some cases easier credit conditions and housing booms (UK, Spain) lowered
the need for precautionary saving and induced overborrowing
26

27. Possible explanations
 In the high-openness cluster, debt is channel positive: higher public savings in
countries with a better fiscal balance is offset by smaller private savings. On aggregate,
total saving is reduced and this in turn lower CA balance. This doesn’t happen in the
low openness cluster
With this consideration in hand, an additional robustness check is done
by curtailing the early years and possibly isolate the disturbancies
27

28. A robustness check with different time periods
Dependent
variable: ca
1974-1998 1991-2011 1999-2011
rer -.3410***
(.0583)
-.0652***
(.0247)
.0091
(.0162)
y -.0421
(.0489)
.1633***
(.0323)
.0737***
(.0135)
debt .0689***
(.0185)
.1069***
(.0150)
.0278***
(.0070)
cred .0153
(.0175)
-.0814***
(.0075)
-.0757***
(.0043)
All regressions include a country-specific constant. Standard errors in parenthesis. ***, ** and * are intended as 1%, 5% and
10% confidence level.
 Importance of real exchange rate weakens in the recent
decades
Income channel insignificant before the introduction of the
Euro, while it’s positive and significant afterwards
28

29. A robustness check with different time periods
 Increasing importance of financial sector over time -> larger
and more integrated financial markets allowed to finance CA
deficit.
These results confirms the finding of Ahearne et al. (2007) and
Blanchard and Giavazzi (2002) -> higher capital markets
integration among EU countries allowed countries with a lower
gdp per capita to borrow more in order to converge towards
richer countries
29

30. Conclusions
The role of trade openness appears to be not negligible in
explaining part of the divergence in current account position in
the EU.
Competitiveness factors strongly affects low openness countries,
while the effects weakens as openess increases
Convergence and credit channels play an increasing role as
financial and capital integration increases: low income countries
and with a bigger credit sector are likely to be associated with a
worse CA balance.
Debt/gdp ratio has a negative impact for trade balance in case of
medium and low-openness countries, positive for high-openness
one.
30

31. Current Account Rebalancing and
Exchange Rate Adjustment in the
United States
31

32. Current account imbalances in the US
While the US continuously increased their trade deficits, emerging
countries (especially China) increased their surpluses.
According to the excess-saving view (Bernanke 2005), the high levels of
saving by these countries are said to have contributed to keep low
interest rates and financed the expenditures in the countries in
deficits.
32

33. Current account imbalances in the US
The goal of this work is to assess the potential consequences for
macroeconomic variables (i. e. real exchange rate and terms of trade)
of a rebalancing.
The focus is essentially concentrated on two main points:
1. The speed of the rebalancing process: in the short run (imperfect
pass-through to prices) the exchange rate depreciation can be
sharp.
2. The role of policy reforms: countries in surplus should concentrate
their efforts to improve the productivity in the non-tradable sector
and reduce the degree of home bias in consumption, countries in
deficits should aim to expand the productivity in the traded goods
sector.
33

34. Literature review
One of the first papers on this issue is Krugman (1985), in which the
author claims US dollar would have required a substantial depreciation
to bring US deficits to a sustainable level.
Obstfeld and Rogoff (2000, 2005, 2007) incorporate terms of trade in
their analysis and suggest a much stronger depreciation to offset the
imbalances
Corsetti et al. (2008): tradables and non-tradables endogenous,
account for varietes.
Eichengreen and Rua (2011): US versus China or other countries
34

35. The model
Starting from Obstfeld and Rogoff (2007), we enrich the analysis by adding
different shocks to the main parameters in the calibration and discussing
what happens in the case of an imperfect exchange rate pass-through to
prices.
ASSUMPTIONS:
 Endowments exogenous for any type of output
 Flexible Prices
 The U.S. as big country, i. e. shocks can alter terms of trade with respect
to the rest of the world
 Perfect pass-through in the long run, but imperfect in the short
 Home bias in consumption: preferences for home produced goods
 Law of one price holds
 Central bank seek to stabilize CPI Inflation
35

36. Consumption
Consumption index for home country:
Where γ is the quota of budget spent for tradables and θ is elast. of
substitution among tradables and non-tradables.
Tradables consumption is given by:
With α (>0.5) is the quota spent on home produced goods and η the
elast. of substitution among home and foreign produced goods
36

37. Prices
Consumer price index (for home country) is given by:
With PT as price for tradables and PN for non-tradables. The first is
composed by prices of home and foreign tradables:
If law of one price for tradable holds, we have , where ε is
nominal exchange rate. It follows that
Terms of trade:
Real exchange rate:
37

38. PPP doesn’t hold in consumption choice among tradables, because of
home bias. Therefore
Real exchange rate:
Market clearing conditions:
CA balance:
With imperfect pass-through:
38

39. Solving the system
Taking as given (exogenously) C, C*, YH, YF, YN and YN* we can solve for
relative prices and get:
(1)
Hence, substituting for and in equation (1) and rewriting the
equations in terms of PHYH and PFYF we have:
(2)
(3)
39

40. Solving the system
(4)
where
And real exchange rate becomes:
(5)
Three of the equation (2-5) are independent, hence we can find a
solution for relative prices , terms of trade τ and real
exchange rate q.
40

41. The analytical implications
The baseline case of letting current account balance (CA) to go to zero
captures the effects of a simulated shock in the aggregate demand big
enough to take current account imbalances to zero
This approach (used by Obstfeld and Rogoff, 2007) is an useful
benchmark, although there’s not a specific reason for which deficits
have to go to zero to stabilize US’ external liabilities.
With a positive GDP growth and given the reserve currency role played
by the dollar, the US might persistently run current account deficits if
they are small enough to be sustainable (Mussa, 2005)
41

42. Calibration
Parameter Value Source
CA -0.03 World Bank
i 0.05 OR (2007)
η 2, 3 OR (2007)
θ 0.5, 1, 2 Lane, Milesi-Ferretti (2004)
w 1, 0.5 Goldberg and Knetter (1997)
γ = γ* 0.25 OR (2007), Eichengreen & Rua (2011)
σN = σN* 1 OR (2007), Eichengreen & Rua (2011)
α 0.7 OR (2007)
α* 0.925 OR (2007)
σT= σT* 0.22 OR (2007)
42

43. A negative demand shock
Full Balance Adjustment scenario with different elasticities and 50 percent pass-through
θ η Fall in TOT (%) Real q Depreciation (%)
1 2 18.44 38.44
2 2 18.44 22.86
1 3 11.22 32.02
2 3 11.22 17.48
0.5 2 18.44 77.12
With imperfect pass-through, in the benchmark case of θ=1 and η=2,
dollar needs to depreciate of about 38 percent to accomplish the
rebalancing process.
Because of home-bias in consumption, the fall in aggregate demand hit
stronger US tradables than foreign ones, therefore terms of trade
declines. Also price of home non-tradables falls, causing further dollar
depreciation.
43

44. A negative demand shock
Central Bank could also stabilize dollar in order to avoid negative effects due
to the sharp fluctuation of the currency. this would cause the relative prices
of non-tradable goods to be too high and, ultimately, to increase
unemployment in that sector.
After the outbreak of Global Crisis of 2008-09, deficits felt from 6 to 3 percent
in 2011 and the dollar depreciated by a smaller amount that what forecasted
here.
However, unemployment hit stronger especially non-tradable sector as Mian
and Sufi (2012) found.
44

45. Adjustment to a sustainable level
CA
converges
to (% to
GDP)
Adjustment scenario to a sustainable level (50% pass-through)
θ = 1, η = 2 θ = 2, η = 3
Fall in TOT (%)
Real q
Depreciation (%)
Fall in TOT (%)
Real q
Depreciation (%)
-2.5 % 3.16 6.42 1.90 2.86
-2.0 % 6.30 12.86 3.78 5.76
-1.5 % 9.38 19.32 5.66 8.66
If we assume that the U.S. can be confident about a future economic
growth so that deficits can be sustainable, dollar doesn’t need to sharply
depreciate as in the full balance scenario.
45

46. A (home) tradable productivity shock (+20%)
Full Balance Adjustment scenario with an Increase in U.S tradables productivity
(100% pass-through)
θ η Fall in TOT (%) Real q Depreciation (%)
1 2 15.79 11.00
2 2 15.79 10.33
1 3 9.70 5.45
2 3 9.70 5.80
0.5 2 15.79 12.66
Altering all parameters including YH (i.e. σN, σT and f) we can test what happens if
adjustment is achieved while US tradable productivity increases.
if the United States expand their productivity in tradable goods, this would help
to accomplish the rebalancing process with a smaller dollar depreciation
-> dollar depreciates by 11 percent only.
Also terms of trade fluctuation is smaller.
46

47. An increase in foreign productivity
Foreign countries, especially the ones in surplus, can implement
policies in order to drive the adjustment process without the danger
and the instability due to sharp currency depreciations.
A shock in foreign productivity for tradables can be seen as the
increased investments in the infrastructure that increases the supply of
exportables.
It is tested a shock in foreign productivity in non-tradable sector as
well: we can think of this kind of shock as an innovation in the retailing
productivity levels of the emerging economies that start to catch up
the levels of the United States
47

48. An increase in foreign productivity
Adjustment scenario with a rise in foreign tradables productivity (Full pass-through)
θ η Fall in TOT (%) Real q Depreciation (%)
1 2 5.18 28.93
2 2 5.18 13.94
1 3 3.10 27.00
2 3 3.10 12.38
0.5 2 5.18 68.15
Adjustment scenario with a rise in foreign non-tradables productivity (Full pass-through)
θ η Fall in TOT (%) Real q Depreciation (%)
1 2 8.92 5.01
2 2 8.92 5.18
1 3 5.42 1.80
2 3 5.42 2.57
0.5 2 8.92 4.74
It is common opinion of analysts that an increase of productivity by emerging
countries can help to reduce the imbalances.
Instead, these results show as this is true only if the an enhanced productivity is
concentrated in non-tradables.
48

49. A shock in consumption preferences
Full Balance Adjustment scenario with a foreign preference shock
(θ = 1, η = 2)
α* Fall in TOT (%) Real q Depreciation (%)
0.825 -26.08 -11.69
0.875
-11.76
0.45
0.925 9.22 19.22
Full Balance Adjustment scenario with a preference shock
(θ = 1, η = 2)
α Fall in TOT (%) Real q Depreciation (%)
0.5 28.09 35.14
0.6
19.29
27.81
0.7 9.22 19.22
The variation in expenditure patterns matters and have a significant impact on
both terms of trade and real exchange rate
A reduction of the home bias in consumption can either make the dollar
appreciate or depreciate depending on whether that change has happened
outside or within the United States
Countries affected by good market rigidities and financial market imperfections
should implement structural reforms towards a greater flexibility
49

50. Caveats and conclusive remarks
In the case in which current account reversal happens too quickly,
consequences for the currency stability can be serious.
Policy implications:
-Higher investment in (non-tradable) productivity for countries experiencing
CA surplus can help to achieve a rebalancing process
- Same is true for policy reforms that improve tradables productivity for
countries in deficits
- A change in the preferences that can reduce the home bias in consumption
allows the CA to reduce without sharp currency depreciations
50

51. Caveats and conclusive remarks
Caveats:
- Relatively simple theoretical structure doesn’t account for the role
played by financial markets
- Static setting doesn’t include possible strategic behaviour (for
instance, retaliation and expansionary monetary policy from central
banks)
- Savers and private investors behaviour (they can start to sell assets
in dollar in case of depreciation expectations)
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52. Estimating pass-through for EU
countries: potential asymmetries play
a role?
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53. Motivation
Understanding how much of the exchange rate variation affects
tradable prices is crucial
For imports, the effects on
domestic inflation are important
with respect to monetary policy
For exports, elasticity to exchange
rate changes is crucial for
competitiveness issues
Existing literature commonly assumes pass-through to price to be
linear and symmetric, but recent studies are showing as asymmetries
often play a non-negligible role.
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54. Campbell (2013) shows as in the case of the US, as real exchange rate
appreciation (late 1990s, early 2000s) strongly hit output, investments
and productivity while, on the contrary a correspondent depreciation
doesn’t have the same effect (hysteresis)
Bussière (2007), analyzing a sample of G7 economies, finds that non-linearities
and asymmetries in exchange rate pass-through can’t be
ignored, although their magnitude varies across States.
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55. With respect to CA imbalances, the aim here is to assess whether price
rigidities with respect to imports (but more importantly to exports) are
present in case of selected EU countries.
To find the elasticity of export prices to exchange rate we can estimate
the following (country by country):
ΔExpt = β0 + β1 ΔExpt -1+ β2 Δ ER+ β3 ΔPPIt+(Controls)+ β(non-linear terms)+εX,T
Similarly, for imports:
ΔImpt = α0 + α 1 ΔExpt -1+ α2 Δ ER + α 3 ΔPPIt+(Controls)+ α(non-linear terms)+εI,T
Set of controls can include: dummy variables, oil prices, GDP, etc
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56. In order to explore the issue of non-linearities is it possible to add
other terms (i.e. exchange rate-squared) and dummy variables
interacted with exchange rate.
In any case, it is possible to obtain 2 estimates of pass-through:
-Short run: β2 and α2
- Long run: β2 /(1- β1) and α2 /(1- α1)
We expect to find that countries more exposed to change in competitiveness
(in our previous chapter Italy, Spain, Portugal) have also a higher degree of
pass-through.
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57. Thanks for your attention!
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