Abstract
The purpose of this chapter is to examine the current account–real exchange rate nexus for the three eurozone south periphery economies of Greece, Portugal and Spain and reach interesting conclusions on whether economic policies targeting the real exchange rate could be beneficial for improving current account balances in these economies. Evidence suggests that a real depreciation in the periphery (as typified by Greece, Portugal and Spain) can lead to an improvement of these economies’ current account balances.
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Notes
- 1.
See Fig. 5.7 in Chap. 5.
- 2.
- 3.
See Section The Twin Deficit Hypothesis.
- 4.
The capital account records the transfer of wealth between countries that has to do with nonmarket activities or activities that reflect the acquisition or disposal of nonproduced, nonfinancial and intangible assets like copyrights and trademarks. For an excellent exposition of the basic balance of payment identities, see Krugman et al. (2012).
- 5.
This is also the case for many other economies worldwide. See Grohé et al. (2016) for such evidence.
- 6.
Although the correspondence between theoretical concepts and their empirical counterparts is often by no means obvious in empirical macroeconomics and international finance, the trade balance could be treated as a reasonable empirical counterpart for the current account balance based on the evidence reported in Tables 7.1 and 7.2 and in Fig. 7.1 for Greece, Portugal and Spain and on the theoretical setup employed in section “The Relationship Between the Current Account and the Real Exchange Rate in the Eurozone Periphery: A Case Study for Greece, Portugal and Spain” of this chapter.
- 7.
See Krugman et al. (2012) for a detailed exposition of the Marshal-Lerner condition.
- 8.
- 9.
The real exchange rate is quoted using the indirect definition, so an increase (decrease) denotes a real appreciation (depreciation).
- 10.
As illustrated in section “Current Account Balances in the Eurozone Periphery: A Case Study for Greece, Portugal and Spain” for all three economies, the trade balance can be treaded as the main component of the current account balance. Consequently, the trade balance is treated as a reasonable proxy in the empirical analysis of this chapter, and the terms trade balance and current account balance are used interchangeably.
- 11.
Data was collected from Eurostat. All variables appear to be stationary, and cointegration is tested following the Johansen (1995) procedures.
- 12.
The main results from the current analysis were validated after running the experiments with the current account (percentage of GDP) as the dependent variable following a wider definition, including net factor payments and net unilateral transfer payments.
- 13.
As opposed to orthogonalised impulse responses, where shocks are orthogonalised using the Cholesky decomposition before estimating the impulse responses (Sims 1980), we employ the generalised impulse response approach as proposed by Pesaran and Shin (1998), building on earlier work by Koop et al. (1996). Overcoming the difficulties behind identification, the generalised impulse responses are crucially invariant to the reordering of the variables (as opposed to the various orthogonalised approaches) by taking into account the historical patterns of correlations amongst the different shocks.
- 14.
Conversely, if a real depreciation leads to a worsening of the trade balance in the short run followed by gradual improvement, this would provide evidence of a J-curve effect. For a detailed analysis behind the J-curve effect, see Krugman et al. (2012).
- 15.
The effects of fiscal austerity in improving the current account balances based on empirical evidence from Greece, Portugal and Spain have also been analysed in Chap. 6.
- 16.
See McDonald (2000).
- 17.
This is the well-known ‘PPP puzzle’ as labelled by Rogoff (1997).
- 18.
For an alternative approach towards the determination of the real exchange rate in the long-run within an inter-temporal optimisation theoretical framework, incorporating an array of different financial assets, see Litsios and Pilbeam (2017).
- 19.
- 20.
The term ‘normal’ adjustment corresponds to the mean adjustment speed as reflected by the estimated coefficient on the net foreign asset position.
- 21.
See Benassy-Quéré et al. (2011) for a full exposition of the theoretical model.
- 22.
The current analysis is focused on the fundamentals that are assumed to influence the real exchange rate in the long-run. However, the Z t vector in Eq. (7.2) may also incorporate fundamentals with persistent effects in the medium run, like the real interest rate differential. Since we want to estimate the equilibrium path that the real exchange rate may follow in the long-run and subsequently its total misalignment, we focus only on the fundamentals with persistent effect in the long-run, and we express them in terms of their sustainable or desired level as reflected by their trend values.
- 23.
In the empirical literature, there has been a controversy on the suitability of the various filters, like the HP filter, the bandpass filter and the Beveridge and Nelson (1981) decomposition in the analysis of the business cycles. Prescott (1986) argued that the HP filter is designed to eliminate stochastic components that have periodicities of more than 32 quarters. On the contrary, the bandpass filter developed by Baxter and King (1999) passes through components with periodicities between 6 and 32 quarters. The benefit of the HP filter is that it can extract the same trend from a set of different variables. In our analysis, we define the business cycle as in King and Rebelo (1999) by assuming a cycle with periodicity of 8 years or less.
- 24.
Quarterly data for the post-euro era up to Q4(2016) was collected from the world development indicators.
- 25.
The ARDL is employed due to the fact that not all variables employed in the analysis turn out to be I(1).The ARDL has the advantage of avoiding any classification between I(0) and I(1) variables. In addition, the ARDL is a statistically significant approach to cointegration for relatively small data samples.
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Appendix
Appendix
Define the real exchange rate as \( {q}_t=\frac{E{P}_t}{P_t^{\ast }} \), where E t is the nominal exchange rate, defined as the amount of foreign currency per unit of domestic currency. Typically the balance of trade is defined as the difference between the exports and imports of goods and services. Following the theoretical approach of Boyd et al. (2001), we consider a logarithmic transformation of the balance of trade since such a specification provides an exact measurement of the Marshall-Lerner condition instead of an approximation. In our theoretical setup the ratio of nominal exports to imports tb t is given by Eq. (A.1):
where X t denotes exports, M t imports and P t , \( {P}_t^{\ast } \) the domestic and foreign prices, respectively. Taking a logarithmic transformation of Eq. (A.1) where ℓ denotes a logarithm, we derive Eq. (A.2):
where \( \ell {q}_t=\left(\ell {E}_t+\ell {P}_t-\ell {P}_t^{\ast}\right) \).
Assume that the long-run relationships for imports and exports (in logarithms) are given by Eqs. (A.3) and (A.4):
The long-run determination of the balance of trade (in logarithms) is then given by Eq. A.5, which corresponds to Eq. (7.1) in the text:
where a = α x + α m , and η = (η X + η M − 1), which reflects the Marshall-Lerner condition, according to which in order for a real appreciation (increase in ℓq t ) to deteriorate the current account η X + η M must be greater than unity.
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Baimbridge, M., Litsios, I., Jackson, K., Lee, U.R. (2017). The Relationship Between the Real Exchange Rate and Current Account Imbalances in the Eurozone. In: The Segmentation of Europe. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-137-59013-8_7
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