Trends in European Real Exchange Rates Martin Berka and Michael B. Devereux Victoria University of Wellington and University of British Columbia
Economic Policy, Fifty-sixth Panel Meeting, Nicosia, Cyprus
October 18, 2012
Berka and Devereux (EP)
Trends in European Real Exchange Rates
October 18, 2012
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Plan of Talk 1
Outline the stylized facts about European RER I
I I 2
Account for the RER behaviour I I
I
3
Are RER deviations driven by internal relative prices? Is there evidence for the distribution-sector theories of RER determination? To what extend do GDP differences drive deviations of prices from parity?
Explain European RER with a minimalist model I
4
Very informative data: price levels, 15 years - both pre- and post-euro, 31 countries, 146 goods, uniform collection What are the levels of PPP deviations? Is there a sustained convergence to EU parity?
What is the role relative differences in GDP per capita play over time and across countries?
Policy analysis I I
Is there evidence of overvaluation? Is this more pronounced in crisis countries?
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Real Exchange Rates in Europe Need to compare prices across countries and over time Eurostat data: I I I I
Annual 31 countries: rich, poor, Eurozone, floaters 146 comparable consumer goods 1995-2009: before and after euro
Price Level Indices (PLI’s) I
Good specific PPPs
Benchmarked relative to 15 European countries qjt =
N X
pijt
i=1
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Example qt for Ireland, 1995-2010 xample qt for Ireland, 1995-2010 I
Long appreciation appreciation before before crisis crisis Long
Ireland RER, 1995−2010 1.25 1.2 1.15 1.1 1.05 1 0.95 0.9 1995 Berka and Devereux (EP)
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Have prices converged in Europe? The 12-member Eurozone: I
Belgium, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, Finland F
Occasionally separate Portugal, Italy, Greece and Spain into a sub-group (PIGS)
Floating countries: I
Denmark, Norway, Sweden, Switzerland, UK, Iceland
A group of mostly East European countries (starts in 1999): I
Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia, Bulgaria, Romania and Turkey
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Convergence in the eurozone and east, but not floaters Real exchange rates relative to EU15 parity 1.4
1.3 Floating Europe 1.2
1.1 Eurozone without PIGS
1
0.9 PIGS 0.8
0.7 Eastern Europe
1995
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2005
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2010
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Larger PPP deviations for Nontraded than for Traded RER Traded and Nontraded Real exchange rates 1.4
1.3
Floating Europe
1.2
Eurozone without PIGS
1.1
1
0.9 PIGS 0.8
0.7 Traded RER Eastern Europe
0.6
0.5
Nontraded RER
0.4 1995
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2005
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2010
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All prices 1995
1999
3
3 EU 12 Floating currency countries
2.5 2
2
1.5
1.5
1
1
0.5
0.5
0
0
1
2
3
EU 12 Floating countries Eastern Europe
2.5
4
0
0
1
2
3
4
38 2009
All years
3
3 EU 12 Floating countries Eastern Europe
2.5 2
2
1.5
1.5
1
1
0.5 0
EU 12 Floating countries Eastern Europe
2.5
0.5
0
1
Berka and Devereux (EP)
2
3
4
0
0
Trends in European Real Exchange Rates
1
2
3
4
Figure 3: Kernel density estimates of prices for all goods within a country group by year
Convergence to parity, but movements within distributions
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RER and relative internal prices PN /PT Strong positive relationship, both in levels and growth rates Equally strong in floating and fixed-ER countries All countries, averages levels
All countries, mean annual growth rates 1.4
0.05
1.3
0.04 1.2
0.03
1.1
1 RER
RER
0.02
0.01
0.9
0.8
0.7
0 0.6
−0.01 0.5
−0.02 −0.015
−0.01
−0.005
0
0.005 0.01 PN/PT
Berka and Devereux (EP)
0.015
0.02
0.025
0.03
0.4 0.4
0.5
0.6
Trends in European Real Exchange Rates
0.7
0.8
0.9
1
1.1
1.2
1.3
PN/PT
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Evidence supportive of Distribution channel theory of RER Traded RER at retail level strongly positively related to the relative internal prices (PN /PT ) – across time and countries All countries, averages levels
All countries, mean annual growth rates
1.4
0.05
1.3
0.04
1.2 0.03
1.1
PT
PT
0.02
1
0.01
0.9 0
0.8
−0.01
−0.02 −0.015
0.7
−0.01
−0.005
0
0.005 0.01 P /P
0.015
0.02
0.025
0.03
0.4
0.5
0.6
Berka and Devereux (EP)
0.7
0.8
0.9
1
1.1
1.2
1.3
PN/PT
N T
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Real exchange rate and relative GDP per capita All countries and all time periods Figure 9: Real exchange rate and GDP: pooled 1
0.5
log deviations of RER
0
−0.5
−1
−1.5
−2
−2.5
−2.5
Berka and Devereux (EP)
−2
−1.5 −1 −0.5 log deviations of relative GDP
0
Trends in European Real Exchange Rates
0.5
1
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−2.5
Real exchange rate and relative GDP per capita −2.5
−2
−1.5 −1 −0.5 log deviations of relative GDP
0
0.5
1
Again, similar relationship across countries and over time Average growth rates
Average levels
0.06
0.6
SVK 0.05
0.4 NOR
0.04 CZE
DEN ICE SWI SWE FIN
0.2
ROM
HUN
BUL
average level of RER
average growth rate of RER
LIT 0.03 LAT EST 0.02
SVNIRE ITAMAL POL TUR GRE
0.01
−0.01
−0.02 −0.04
EST TUR LATPOL HUN LIT
−0.6
0 0.02 0.04 0.06 average growth rate of RGDP
Berka and Devereux (EP)
SPA GRE POR
−0.2
−0.4
GER SWI ICE SWE
−0.02
LUX
CYP
MAL SVN
NOR POR CYP SPA DEN BE UK LUX NET FIN FRA AUS
0
IRE AUS UK FRA GER BE ITA NET
0
0.08
0.1
−0.8 −3
ROM BUL −2.5 −2
Trends in European 45 Real Exchange Rates
SVK
CZE
−1.5 −1 −0.5 average level of RGDP
0
0.5
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Real exchange rate and relative GDP per capita
BE
GER
GRE
SPA
FRA
IRE
2
2
2
2
2
2
1.5
1.5
1.5
1.5
1.5
1.5
1
1
0.5 1995 2000 2005
1
0.5 1995 2000 2005
ITA
1
0.5 1995 2000 2005
LUX
1
0.5 1995 2000 2005
NET
1
0.5 1995 2000 2005
AUS
0.5 1995 2000 2005
POR
FIN
2
2
2
2
2
2
1.5
1.5
1.5
1.5
1.5
1.5
1
1
1
1
1
0.5 1995 2000 2005
0.5 1995 2000 2005
SWE
0.5 1995 2000 2005
DEN
0.5 1995 2000 2005
UK
1
0.5 1995 2000 2005
ICE
0.5 1995 2000 2005
NOR
SWI
2
2
2
2
2
2
1.5
1.5
1.5
1.5
1.5
1.5
1
1
1
1
1
0.5 1995 2000 2005
0.5 1995 2000 2005
Berka and Devereux (EP)
0.5 1995 2000 2005
0.5 1995 2000 2005
Trends in European Real Exchange Rates
RER GDP
1
0.5 1995 2000 2005
0.5 1995 2000 2005
October 18, 2012
Figure 8: Relative GDP per capita and average PLI’s in Western Europe
Close alignment of levels and changes of GDP and RER (except Luxembourg)
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Real exchange rate and relative GDP per capita Highly statistically significant The average RER-GDP elasticity 0.35 - 0.4 Higher for non-traded (0.55 - 0.6) than for traded goods (0.26 - 0.35) Larger and more significant in the West than East Table 3. Price level regressions (average country price)
All goods and services Traded go Pooled Country FE Period FE Country and Pooled Country F 1 2 3 Period FE 4 log(RGDP) 0.35∗∗∗ 0.34∗∗∗ 0.35∗∗∗ 0.36∗∗∗ 0.26∗∗∗ 0.29∗ (0.01) (0.04) (0.01) (0.05) (0.01) (0.0 Euro dummy -0.06∗∗∗ -0.001 -0.08∗∗∗ -0.008 -0.07∗∗∗ -0.0 (0.02) (0.009) (0.02) (0.02) (0.02) (0.0 log(Distance) 0.08∗∗∗ – 0.08∗∗∗ – 0.1∗∗∗ (0.02) (0.02) (0.01) log(G/Y) 0.07 0.25 0.07 0.02 0.07 0.0 (0.08) (0.08) (0.08) (0.08) (0.07) (0.0 ∗ ∗∗ ∗∗ ∗∗ log(Openness) -0.05 -0.15 -0.05 -0.14 -0.01 -0 (0.03) (0.07) (0.03) (0.06) (0.02) (0.0 2 R 0.94 0.98 0.95 0.98 0.91 0. N 397 397 397 397 397 3 Dependant variable: Logarithm of price level relative to EU15. All standard errors computed u errors in parentheses. The estimate of the constant is not reported. A Berka and Devereux (EP)
Trends in European Real Exchange Rates
∗
denotes 10%,
October 18, 2012
∗∗
5% and
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Real exchange rate and relative GDP per capita Even with all disaggregated prices, 50% of variation explained by RGDP Table 5. Price level regressions, all prices
log(RGDP) Euro dummy log(Distance) R2 N
All goods Pooled Country FE 1 2 0.39∗∗∗ 0.42∗∗∗ (0.002) (0.01) -0.04∗∗∗ -0.001 (0.003) (0.004) 0.1∗∗∗ – (0.002) 0.47 0.49 60,298 60,298
Traded Pooled Country FE 3 4 0.28∗∗∗ 0.35∗∗∗ (0.006) (0.01) -0.05∗∗∗ -0.0002 (0.005) (0.004) 0.1∗∗∗ – (0.005) 0.43 0.45 40,061 40,061
Non-Traded Pooled Country FE 5 6 0.62∗∗∗ 0.58∗∗∗ (0.01) (0.03) -0.014 -0.004 (0.009) (0.008) 0.11∗∗∗ – (0.01) 0.69 0.72 20,237 20,237
Dependant variable: Logarithm of price level relative to EU15. Standard errors in parentheses. The standard errors in this three-dimensional panel were computed using Newey-West standard errors. A 5% and
∗∗∗
∗
denotes 10%,
∗∗
1% significance.
6. (EP) Price Berka andTable Devereux
level regressions in Real differences Trends in European Exchange Rates
October 18, 2012
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Evaluating European real exchange rates
European real exchange rates track internal relative price of Nontraded to Traded Goods very closely European real exchange rates closely tied to RGDP per capita Very similar process across countries and over time Develop a simple ‘rule of thumb’ structural model to assess RGDP-driven real exchange rates
Berka and Devereux (EP)
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October 18, 2012
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A Simple General Equilibrium Model
Develop a model to replicate 1 2
Strong cross section and time series relationship between RER and GDP Strong relationship between RER and PN /PT
Essentially a simplified Balassa-Samuelson type model I
But sufficiently general to allow for other supply-side mechanisms (e.g., Bhagwati 1984)
But assuming exogenous GDP Are European RER’s driven by similar forces in all countries?
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October 18, 2012
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A 2 country endowment economy model Home country consumption aggregate: C=
γ
1 θ
1− 1 CT θ
+ (1 − γ)
1 θ
1− 1 CN θ
θ θ−1
Tradable Consumption is: CT = Price Indices:
ω
1 λ
1− 1 CX λ
+ (1 − ω)
1 λ
1− 1 CM λ
λ λ−1
1 1−θ P = γPT1−θ + (1 − γ)PN1−θ 1 1−λ 1−λ PT = ωPX1−λ + (1 − ω)PM
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Need to allow for domestic content of T goods Traded consumption aggregators: CX
φ1 1 1−φ1 1 1− 1 1− φ1 φ1 φ 1 1 + (1 − κ1 ) φ1 IXN = κ1 IX
CM
1 φ2 1−φ2 1 1− φ1 φ1 2 φ1 1−φ2 = κ2 IM + (1 − κ2 ) IMN
Real Exchange Rate Definition: RER =
P P∗
The home budget constraint is given by: PC = PX YX + PN YN ,
Berka and Devereux (EP)
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October 18, 2012
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Model Calibration and Solution Calibration is standard I
θ = 0.65, λ = 2 NT goods 50% of GDP
Procedure: I I
Take Y as given from data Choose elasticity of Y (N) to Y to replicate overall RER elasticity of GDP of .39
YN = Y b Simulate model separately for each country with identical parameters Countries differ only by exogenous feed-in of RGDP Compare model RER with sample path RER Evaluation of model based on closeness of two RERs Note this is clearly fundamentals based RER Berka and Devereux (EP)
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Results for Eurozone countries: closeness of Black to Red BE
GRE
GER
1.1
1.3
1
1.2
0.9
1995
2005
0.8 1995
FRA
0.6
0.5 2000
2005
1995
IRE
2000
2005
1995
ITA
1.2
1.4
1.1
1.1
1.2
1
1
0.7
0.6
0.9
2000
0.8
0.7
1
0.9
0.9
0.8
1.1 1
SPA 1
2000
2005
LUX 2.5
2
0.9
1
1.5 0.9
1995
0.8
0.8 2000
2005
1995
NET
2000
2005
AUS
1 2000
2005
1995
POR
2000
2005
FIN
1.3
1.15 1.1
1.2
1.05 1 0.95
2005
Berka and Devereux (EP)
1.3
0.8
1.2
0.7
1
0.6
1995
RERdata RERmodel GDP
1.1 1
0.5
0.9 2000
0.9
1.1
0.9 0.85 1995
0.7 1995
Figure 10: Model prediction and Average PLI’s in EU12
1.2
0.9 2000
2005
1995
2000
2005
Trends in European Real Exchange Rates
1995
2000
2005
October 18, 2012
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Results for Floating countries: closeness of Black to Red
Figure 11: Model prediction and Average PLI’s in countries with floating exchange rat DEN
SWE 1.3
1.4
1.2 1.1
1.2
1 0.9 1995
2000
2005
1 1995
2000
UK 1.6
1.2 1.1
1.4
1
1.2
0.9
1
0.8 1995
2000
2005
0.8 1995
2000
NOR
2005 SWI
2 1.8 1.6
1.8
RERdata
1.6
RERmodel GDP
1.4
1.4
1.2
1.2 1995
2005 ICE
2000
Berka and Devereux (EP)
2005
1 1995
Trends in European Real Exchange Rates
2000
2005
October 18, 2012
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CYP
CZE
EST
HUN
LAT
1
1
1
1
1
0.8
0.8
0.8
0.8
0.8
0.6
0.6
0.6
0.6
0.6
0.4
0.4
0.4
0.4
0.4
0.2
0.2
0.2
0.2
0.2
0
0
0
0
20002002200420062008 LIT
20002002200420062008 MAL
20002002200420062008
20002002200420062008
POL
0
SVK
SVN
1
1
1
1
1
0.8
0.8
0.8
0.8
0.8
0.6
0.6
0.6
0.6
0.6
0.4
0.4
0.4
0.4
0.4
0.2
0.2
0.2
0.2
0.2
0
0
0
0
20002002200420062008 BUL
20002002200420062008 ROM
20002002200420062008
20002002200420062008
20002002200420062008
0
20002002200420062008
TUR
1
1
1
0.8
0.8
0.8
0.6
0.6
0.6
0.4
0.4
0.4
0.2
0.2
RER
0
20002002200420062008
0
Berka and Devereux (EP)
data
RERmodel GDP
0.2 20002002200420062008
0
20002002200420062008
Trends in European Real Exchange Rates
October 18, 2012
Figure 12: Model prediction and Average PLI’s in Southern and Eastern Eur
Results for East European countries: closeness of Black to Red
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Results of simulation For Eurozone countries except PIGS I I
Model close to sample, except Finland and Luxembourg Model matches well in Ireland
In PIGS I I
Evidence of ‘misalignment’ in Greece, Italy, Portugal Model much closer to data for Spain
Floating currency countries I I
Very high prices in Scandinavia Resolved for most in model with differential VAT
In east Europe I
Mostly a close match, or under-prediction
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Trends in European Real Exchange Rates
October 18, 2012
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Policy implications Exogenous output process limits normative implications endogenous output
z}|{ ?→ Y → RER Endogenous output I I
deviate from efficient due to nominal and real rigidities endogenous growth (e.g., externalities to human capital accumulation)
Implications for optimal policy, and thus RER Example: documented capital inflows into PIGS (early 2000s) I I I
excessive GDP growth RER appreciation Consequences of excessive borrowing for wage, real estate inflation
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Trends in European Real Exchange Rates
October 18, 2012
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Policy implications
Even with exogenous Y , distortions in financial markets financial market imperfections
?→Y
z}|{ →
RER
e.g., exchange rate ”disconnect” Absent such distortions, RERs predicted by our model can be taken as the efficient RER levels and growth rates I
Conditional on YT , YN paths, and other assumptions
Berka and Devereux (EP)
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October 18, 2012
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Policy implications Recent discussion of RER overvaluation in Greece, Portugal and Italy (Spain less) All exhibit RER above our model-implied efficient RER
Ireland: appreciation mostly efficient Finland: accounted by higher relative VAT rates Berka and Devereux (EP)
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Policy implications an anomaly), as well as the average growth rate in the deviation (in percentage points). It shows that Greece and Portugal stand out as having substantial positive deviations between the actual and model implied real exchange rates (and with the caveat of the previous paragraph, Finland), followed by Spain and Italy. It is noteworthy however that this deviation did not always increase over the duration of the sample. This is
Average overvaluation in Greece, Portugal, Italy
clear both from the Table and from Figure 10. The implied overvaluation of Greece and Spain actually fell very slightly during the sample. Only for Italy do we find that the
But, except for Italy, overvaluation declining slowly
overvaluation increased steadily (at an average rate of 1.1 percent) over the period of the data. Dev. Growth
BE 1.1 0.3
GER 0.8 0.5
GRE 13.2 -0.1
SPA 4.8 -0.2
FRA 2.9 0.1
IRE 2.8 0
ITA 7.1 1.1
NET -5.1 -0.3
AUS 1 0.1
POR 16.1 0.3
FIN 14.3 -0.1
Figure 11 may be used to infer the same information from the floating exchange rate countries. In this case, we find significant overvaluation (according to this measure), especially for Sweden, Denmark and Iceland. But again, when we incorporate di↵erential
Overvaluation notable in some floaters: Iceland
taxation, Berka and Devereux (2012) show that Sweden and Denmark show significantly
East European countries: efficient or undervalued
less overvaluation, while Iceland’s degree of overvaluation is still significantly large. This is particularly relevant since Iceland was one of the crisis countries, and is generally thought to have exhibited substantial real exchange rate overvaluation prior to the crisis. For the Eastern European countries, the picture is more mixed, with some countries displaying undervaluation and some overvaluation, according to this measure. Overall it is noteworthy that the model and sample real exchange rate is quite close for most of these countries. A major component the euro crisis relates not to exchange but 18, 2012 Berka and Devereux of (EP) Trends in European Real Exchange rate Ratesovervaluation October
28 / 30
Unit labour costs Large overvaluation of ULC in Greece, Spain and Portugal Persistent appreciation for Greece, Spain, Portugal and Italy Consistent with low cross-border labour mobility Disconnect between Y, RER, ULC for PIGS GER
GRE
SPA
FRA
IRE
1.2
1.2
1.2
1.2
1.2
1.1
1.1
1.1
1.1
1.1
1.1
1
1
1
1
1
1
0.9
0.9
0.9
0.9
0.9
0.9
0.8
0.8
0.8
0.8
0.8
0.8
0.7 1995 2000 2005
0.7 1995 2000 2005
0.7 1995 2000 2005
0.7 1995 2000 2005
0.7 1995 2000 2005
ITA
LUX
NET
AUS
0.7 1995 2000 2005
POR
FIN
1.2
1.2
1.2
1.2
1.2
1.2
1.1
1.1
1.1
1.1
1.1
1.1
1
1
1
1
1
1
0.9
0.9
0.9
0.9
0.9
0.9
0.8
0.8
0.8
0.8
0.8
0.8
0.7 1995 2000 2005
0.7 1995 2000 2005
0.7 1995 2000 2005
0.7 1995 2000 2005
0.7 1995 2000 2005
SWE 1.2 1.1
DEN
UK
ICE
0.7 1995 2000 2005
NOR
1.4
1.4
1.4
1.4
1.2
1.2
1.2
1.2
RER ULC
1 0.9 0.8 0.7 1995 2000 2005
1
1
1
1
0.8
0.8
0.8
0.8
0.6 1995 2000 2005
0.6 1995 2000 2005
0.6 1995 2000 2005
0.6 1995 2000 2005
Berka and Devereux (EP)
Trends in European Real Exchange Rates
October 18, 2012
Figure 14: Unit Labour Costs and Real Exchange Rat
Unit Labour Cost measure is the OECD.Stat Annual ULC measure, d of total labour costs and real output, for sector ”Total economy”. It is to the OECD.Stat annual ULC aggregate for EU17.
BE 1.2
29 / 30
Conclusions Broad new dataset of comparable disaggregated price levels Substantial deviations from PPP at aggregate and disaggregated levels, in eurozone and non-eurozone countries I
Except for east Europe, PPP deviations non-diminishing
RER accounted for by relative internal price deviations I
Support for distribution channel models of RER: retail-level differences of prices of traded goods accounted by PN /PT
Relative GDP differences explain large fraction of RER I
Similar across countries and over time
A simple model driven by relative sectoral output differences explains RER well. I
To the extent that financial distortions are absent in Europe, our model RER is efficient
Policy implications: large and non-diminishing RER overvaluations in PIGS but not Ireland. Worse with ULC. Berka and Devereux (EP)
Trends in European Real Exchange Rates
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