One of the best channels via which accommodative monetary policy can boost economic growth is by depreciating the currency. Depreciation of the local currency stimulates a country's exports as these become cheaper for foreign buyers. Nonetheless, some recent studies suggest that this relationship between the exchange rate and exports has weakened over the last few years.
Various elements have been proposed as the causes of this reduction in sensitivity but the most important is undoubtedly the proliferation of global value chains (GVC). Specifically, a country is considered to form part of a GVC when its exports, in addition to being made up of value added generated in the country itself, also contain a relevant proportion of intermediate goods and services from other economies. In this case the price of such exports will depend both on local costs and also on the cost of the intermediate goods and services that have been imported. If the country's currency depreciates, from a foreign point of view the cost of the locally-produced share of the exports falls as the local currency has become cheaper in comparison with the foreign currency. However, the cost of the inputs imported remains constant in foreign currency terms and becomes more expensive in local currency terms. This means that, when the local currency depreciates, the price of exports produced within GVCs falls less (once again, for foreign countries) than if the exported goods had been produced locally in their entirety, and the stimulus provided by this depreciation for exports is therefore smaller.
Conversely, other global phenomena might have strengthened the relationship between the exchange rate and exports; in particular, new countries entering the arena of world trade and the liberalisation of some markets. Both elements increase competition with the result that exchange rate movements cannot be absorbed as easily via company mark-ups and therefore have a greater effect on prices. And as prices directly affect the demand for exports, when prices are more sensitive to a currency's exchange rate, the volume of exports is also more sensitive to such exchange rate movements.
Given the co-existence of elements that may have weakened and also strengthened the exchange rate elasticity of exports, various empirical studies have attempted to quantify this and track its evolution over time. The conclusion is controversial. While one recent report by the World Bank states that this link has indeed weakened and that GVCs are responsible for a considerable part of the change, the IMF finds no evidence to support such a conclusion in its «World Economic Outlook» for October 2015 (WEO).1 Along the same lines as the World Bank study, the ECB mentions a certain weakening of the relationship in the case of exports of manufactured goods from European countries, and the Fed for the same case in the US.2
Using the findings from these studies to assess the euro area's current situation, the euro's recent depreciation of close to 5% in real terms against its trading partners would have increased the volume of exports by between 3% and 3.8%; an improvement which, although clearly below the figure of 5.5% that would have been recorded a few years ago in a less integrated world, is nevertheless significant. Consequently, although there is perhaps less sensitivity between exchange rate movements and exports, their relationship is far from over.
1. See Ahmed, S., Appendino, M. A. and Ruta, M. «Depreciations without exports? Global value chains and the exchange rate elasticity of exports.» World Bank Policy Research Working Paper (August 11, 2015). In this article the authors find that the effect of the real exchange rate on exports decreased by almost half between 1996 and 2012 and that GVCs lie behind 40% of this reduction. See also IMF, World Economic Outlook (October 2015), chapter 3.
2. See Di Mauro, F., Rüffer, R. and Bunda, I. (2008), «The changing role of the exchange rate in a globalised economy». ECB Occasional Paper 94.
