Abstract
The 2010/11 European debt crisis has revived the discussion concerning the optimal adjustment strategy in the face of asymmetric shocks. This paper approaches the question from a theoretical perspective by confronting exchange rate based adjustment with crisis adjustment via price and wage cuts. Econometric estimations yield a negative impact of exchange rate flexibility/volatility on growth, which is found to be particularly strong for countries with asymmetric business cycles and during recessions. Price flexibility is found to have a positive impact on growth. Based on these findings we support a further enlargement of the European Monetary Union and recommend more exchange rate stability for the rest of the world.
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Notes
The implied trade-off is behind the choice made by most Central and Eastern European countries to adhere to the Stability and Growth Pact. Even if they were not formally obliged to the pact, they coped with asymmetric shocks through internal adjustments (Babetski et al. 2004).
The economy is defined as balanced when aggregate saving is equal to aggregate investment (S = I). The interest rate which equals saving and investment is called “natural interest rate”. Due to competition banks keep interest rate below the natural interest rate, although during the boom investment is rising. This causes over- or malinvestment during the boom (Hoffmann and Schnabl 2011a, b).
The transition experience in Central and Eastern Europe illustrates in a radical way this process of creative destruction, characterised by bankruptcies and the entry of new firms with completely new forms of ownership (Hanousek et al. 2007).
The integration of the Greek capital markets into the euro area did–in contrast to Mundell (1961, 1973)–not help to absorb the 2010 asymmetric shock. Instead, the lower transaction costs for intra-European capital flows after the euro introduction contributed to the real divergence among the members of the common currency before the crisis and further aggravated the shock during the crisis.
Schumpeter (1911: 356–358) stresses the role of the government in preventing recessions in fulfilling their tasks of cleansing the economy from uncompetitive enterprises. Tolerating trusts, providing public subsidies because of extraordinary circumstances or tariff protection are identified as tools to circumvent the bankruptcy of enterprises.
Duchêne et al. (2004) as well as Fidrmuc and Maurel (2004) interpret the high economic growth of countries with fix exchange rate regimes during the 1990s in the same vein. Purfield and Rosenberg (2010) provide empirical evidence for the successful restructuring process of the Baltic countries during the recent crisis.
The following data series from IMF International Financial Statistics are used: rf for nominal exchange rates against the dollar, 63 for consumer prices, 64 for producer prices, 60b or alternatively 60a or 60c for interest rates dependent on availability. Real growth rates at yearly frequencies are gross domestic products at constant prices in percent changes from the IMF World Economic Outlook. Missing data were filled by sources from national central banks.
\( inde{x_i} = \left| {outputga{p_i} - outputga{p_j}} \right| \) with i being the countries of our sample and j being the reference countries, i.e. Germany for the European countries, France for Germany, and the US for the rest of the world.
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Acknowledgement
We thank Evcen Kočenda, Pichard Pomfret, George Tavlas and an anonymous referee for useful comments. We also benefited from comments by STUDIUM conference participants in Orléans, France, in February 2011, 3–4th.
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Maurel, M., Schnabl, G. Keynesian and Austrian Perspectives on Crisis, Shock Adjustment, Exchange Rate Regime and (Long-Term) Growth. Open Econ Rev 23, 847–868 (2012). https://doi.org/10.1007/s11079-011-9227-z
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DOI: https://doi.org/10.1007/s11079-011-9227-z
Keywords
- Exchange rate regime
- Crisis
- Shock adjustment
- Theory of optimum currency areas
- Mundell
- Schumpeter
- Hayek
- Competitive depreciations