Exchange rate movements still have sizable effects on exports and imports, according to new research from the International Monetary Fund.
Recent currency movements have been unusually large. The US dollar is up more than 10% in real effective terms since mid-2014. The yen is down more than 30% since mid-2012 and the euro by more than 10% since early 2014. Brazil, China, and India have also seen unusually large changes in their currency values, IMF reported.
Not surprisingly, these movements have kindled a debate on their likely effects on trade. Some predict strong effects on exports and imports, based on conventional economic models. Others argue that the increasing fragmentation of production across different countries–the so-called rise of global value chains–means that exchange rates matter far less than they used to for trade, and may have disconnected altogether.
This is an important debate, says Daniel Leigh, Deputy Division Chief in the Research Department, and lead author of the report. “A disconnect between exchange rates and trade would complicate policymaking. It could weaken a key channel for the transmission of monetary policy, and complicate the reduction of trade imbalances, as in the case of imports exceeding exports, via the adjustment of relative trade prices.”
Lessons From History
Concerns about a disconnect between exchange rates and trade are not new. Back in the 1980s, the US dollar depreciated, and the yen appreciated sharply after the 1985 Plaza Accord, but trade volumes were slow to adjust. Some commentators then suggested a disconnect between exchange rates and trade.
But by the early 1990s, US and Japanese trade balances had adjusted, largely in line with the predictions of conventional models.
The question is whether this time is different, or whether the apparent disconnect between exchange rates and trade will once again dissipate.
A new study, for the October 2015 World Economic Outlook, contributes to the debate by taking stock of the relationship between exchange rate movements and exports and imports.
The study examines the experience of both advanced and emerging market and developing economies over the past three decades—a broader sample than is typically examined. It uses both standard trade equations and an analysis of historical cases of large exchange rate movements.
“We find that, on average, a 10% real effective exchange rate depreciation comes with a rise in real net exports of 1.5% of GDP,” says Leigh, noting that there is substantial variation around this average. “Although it takes some years for the effects to fully materialize, much of the adjustment occurs in the first year,” he says.
Among economies experiencing currency depreciation, the rise in exports tends to be greatest for those with slack in the domestic economy and financial systems operating normally.
