The Macroeconomic Effects of Large Exchange Rate Appreciations

The aim of this paper is to provide an empirical backbone to the debate about the macroeconomic effects of large upward exchange rate adjustments of tightly managed or pegged exchange rate regimes. Using a large cross-country dataset covering almost 50 years of international economic history between 1960 and 2008, we study the empirical record of large exchange rate appreciation and revaluation shocks. Our goal is to provide systematic evidence on the macroeconomic lessons that can be learned from these episodes. Our approach is the following: in a first step, we identify large exchange rate appreciations and revaluations. Our definition of a large exchange rate event comprises a 10 percent (or larger) appreciation of the nominal effective exchange rate over a two-year window (or less), leading to sustained real effective appreciation. We hence limit ourselves to studying such nominal exchange rate appreciations that have led to large movements in real exchange rates. We require the appreciation to be sustained in real terms over at least five years. From 1960, we identify 25 episodes of large nominal and real appreciations in a sample of 128 countries of developing and advanced economies. Having identified these events, we ask in a second step how these affected the current account balance and output using a dummy variable augmented autoregressive panel model. We also split our sample and look at differences between advanced and developing countries in response to nominal and real appreciation shocks. We establish four central empirical regularities. First, the current account balance typically deteriorates strongly in response to appreciation and revaluation shocks. Three years after the strengthening of the exchange rate, the current account balance falls by about three percentage points of GDP as a function of decreased savings with stable investment rates. Second, the effects on output are limited. The negative effect on the level of output amounts to a modest 1 percent after six years. The confidence intervals are wide and the results are statistically insignificant. Third, while aggregate output is not strongly affected, export growth falls significantly after appreciation and revaluation shocks. Finally, most of these effects seem to be more pronounced in developing countries.

Kappler, Marcus, Helmut Reisen, Moritz Schularick and Edouard Turkisch (2011), The Macroeconomic Effects of Large Exchange Rate Appreciations, ZEW Discussion Paper No. 11-016, Mannheim.