The paper investigates the link between domestic demand pressure and exports by considering an error correction dynamic panel model for eleven euro area countries over the last two decades. The results suggest that there is a statistically significant substitution effect between domestic and foreign sales. Furthermore, this relationship appears to be asymmetric, as the link is much stronger when domestic demand falls than when it increases. Weakness in the domestic market translates into increased efforts to serve markets abroad, but, conversely, during times of boom, exports are not negatively affected by increasing domestic sales. This reorientation towards foreign markets was particularly important during the crisis period, and thus could represent a new adjustment channel to strong negative domestic shocks. The results have important policy implications, as this substitution effect between domestic and external markets might allow the euro area countries under stress to improve their trade outcomes with a relatively small downward pressure on domestic prices.
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All the estimation results presented have been obtained using the usual fixed effects estimator. One should mention that the presence of the lagged endogenous variable might suggest the use of the well-known Arellano and Bond (1991) procedure. Firstly, the several estimation exercises conducted, using the Arellano and Bond procedure, to assess the sensitivity of the results to the estimation procedure pointed to qualitatively similar findings. Secondly, one should stress that the latter method has been developed for panels with a short time dimension and a very large number of cross-section observations. When the number of periods is large and the cross section is small, the use of this alternative estimator may lead to a loss of efficiency. On the other hand, the fixed effects estimator becomes consistent as the number of periods gets large [see Nickell (1981) and Alvarez and Arellano (2003)].
The long-run elasticities of price competitiveness (given by the ratio between the coefficient of the real effective exchange rate and the speed of adjustment) are 0.82, 1.00 and 0.73 for the models using the indicators based on the GDP deflator, the CPI and the ULCT, respectively.
Before its exclusion from the regressions presented above, the coefficient associated with positive changes of domestic demand presented a value close to zero with a very low t-ratio.
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Bobeica, E., Esteves, P.S., Rua, A. et al. Exports and domestic demand pressure: a dynamic panel data model for the euro area countries. Rev World Econ 152, 107–125 (2016). https://doi.org/10.1007/s10290-015-0234-9
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