Monday, July 11, 2011

11/07/2011: Real value of the Euro and Irish trade

A new paper from IMF looks at the effects of Euro currency valuations and the effect on competitiveness-trade links for trade within the Euro area and for trade outside the Euro area. The study, authored by Tamim Bayoumi, Richard Harmsen and Jarkko Turunen and titled Euro Area Export Performance and Competitiveness is available from the IMF as a working paper from June 2011, IMF WP/11/140.

The main issue assessed is: "Concerns about export growth within the euro area peripheral countries due to a lack of competitiveness within the euro area are a key policy issue."

The main results are:
  1. Long-term price elasticities for exports within the euro area are at least double those for exports outside euro area. In other words, exports outside the euro area are much less responsive, in the long term, to price changes than exports within the euro area. Which, of course, is good news for countries with diversified direction of exports. Ireland is a relatively good performer here, as we re-exports to the US, UK and as our exports to the rest of the world are also growing.
  2. (1) above means that traditional real effective exchange rate indexes may overstate the effectiveness of euro depreciation in restoring exports growth in the euro area periphery. Specifically, the study shows that Real Effective Exchange Rate metrics of competitiveness yield highly volatile effects on countries exports. Wholesale Price Indices-based measures provide a better metric for competitiveness within the Euro area and poorer metrics for competitveness for exports outside the euro area. Unit Labour Cost-based competitveness metrics too perform best for trade within the euro area, but are signifcant performance metrics for outside the euro area exports as well. (Note - in my own analysis on this blog, I use consistently only ULC-based metrics). Finally, CPI-based metrics are yeilding totally counter-intuitive results and represent the poorest metric.
  3. So, per (2), the pace of deterioration in exports due to appreciation of the euro, depends on the measure of relative prices used.
In particular, the four REER indicators for the peripheral countries "give only partial support to the much-discussed view that external competitiveness deteriorated significantly since the adoption of the euro became likely enough that interest rates started to narrow":
  • In Ireland, the CPI-based REER has appreciated by about 20 percent since 1995, while the WPI- and ULC-based REERs have depreciated by about 20-30 percent over this time period.
  • Portugal shows similar divergences.
  • While Italy’s competitiveness does appear to have eroded, the size of this effect is, frankly, anyone’s guess—while the CPI- and WPI-based measures show only modest appreciation since 1995, the ULC- and XUV-based indicators have appreciated by about 50 and 110 percent, respectively.
  • The data for Greece and Spain show a more consistent story, involving steady appreciation of some 10-40 percent on all four measures.
You can read the charts below just as you read my charts on Harmonized Competitiveness Indicators: higher values mean bad things. Higher REERs in the second figure reflect export-related REERs for wthin and outside the Euro area trade.

Figure 1. Real Effective Exchange Rates in Euro Area Countries, 1995 to 2009 , Index 1995 = 100

Figure 2. Real Effective Exchange Rates in Euro Area Countries: Intra/Extra-Euro Area, 1995 to 2009, Index 1995 = 100

"There is surprisingly large variation across our four measures of extra- and (in particular) intra-euro area relative prices—based on wholesale prices, consumer prices, unit labor costs, and export unit values. For some countries, such as France and Ireland, the picture becomes clearer if one ignores the CPI price series that generate unconventional results".

All together, a very interesting study which suggests that in particular for Ireland, intra-Euro area trade has been consistent with continuously depreciating Euro, while extra-Euro trade is consistent with consistently appreciating Euro. Since exports within Euro area are more price-sensitive than exports outside Euro area, this clearly explains, at least to some extent, why nominally appreciating Euro (in Forex markets) had so far little adverse effect on Irish trade outcomes: we benefit from effective real devaluation within the Euro zone and are not signficantly hurt by effective euro appreciation outside the Euro area.

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