How have global shocks impacted the real effective exchange rates of individual euro area countries since the euro’s creation?

Abstract

This paper uncovers the response pattern to global shocks of euro area countries' real effective exchange rates before and after the start of Economic and Monetary Union (EMU), a largely open ended question when the euro was created. We apply to that end a newly developed methodology based on high dimensional VAR theory. This approach features a dominant unit to a large set of over 60 countries' real effective exchange rates and is based on the comparison of two estimated systems: one before and one after EMU. We find strong evidence that the pattern of responses depends crucially on the nature of global shocks. In particular, post-EMU responses to global US dollar shocks have become similar to Germany's response before EMU, i.e. to that of the economy that used to issue Europe's most credible legacy currency. By contrast, post-EMU responses of euro area countries to global risk aversion shocks have become similar to those of Italy, Portugal or Spain before EMU, i.e. of economies of the euro area's periphery. Our findings also suggest that the divergence in external competitiveness among euro area countries over the last decade, which is at the core of today's debate on the future of the euro area, is more likely due to country-specific shocks than to global shocks.

Theory and Practice of Gvar Modelling

“…Bussière et al . () find that the responses of real effective exchange rates of euro area countries to a global risk aversion shock after the creation of euro have been similar to the effects of such shocks on Italy, Portugal or Spain before the European monetary union, that is, of economies in the euro area's periphery. Moreover, their findings suggest that the divergence in external competitiveness among euro area countries over the past decade, which is at the core of today's debate on the future of the euro area, is more likely due to country‐specific shocks rather than to global shocks.…”

“…Effects of risk shocks are also scrutinized in Bussière et al . () for a monthly panel of real effective exchange rates featuring 62 countries. Bussière et al .…”

Theory and Practice of GVAR Modeling

“…They also …nd some interesting di¤erences over di¤erent types of economies, with Europe being more adversely a¤ected by the fall in risk appetite than other advanced economies. E¤ects of risk shocks are also scrutinized in Bussière, Chudik, and Mehl (2011) for a monthly panel of real e¤ective exchange rates featuring 62 countries. Bussière, Chudik, and Mehl (2011) …nd that the responses of real e¤ective exchange rates of euro area countries to a global risk aversion shock after the creation of euro have become similar to those of Italy, Portugal or Spain before the European monetary union, i.e.…”

Theory and Practice of GVAR Modeling

“…E¤ects of risk shocks are also scrutinized in Bussière, Chudik, and Mehl (2011) for a monthly panel of real e¤ective exchange rates featuring 62 countries. Bussière, Chudik, and Mehl (2011) …nd that the responses of real e¤ective exchange rates of euro area countries to a global risk aversion shock after the creation of euro have become similar to those of Italy, Portugal or Spain before the European monetary union, i.e. of economies in the euro area's periphery.…”