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That’s the conclusion of a new paper that Tyler Cowen has linked to. And I think that’s right. Many stimulus advocates (including me and Lars Svensson) have pointed out that currency depreciation caused by monetary stimulus would not be expected to boost net exports, as the substitution effect will often be dominated by the income effect (a booming economy sucking in more imports.)

Unfortunately, the paper (by Alberto Bagnai and Christian Alexander Mongeau-Ospina) starts off with a misleading summary of the results:

It is frequently claimed that the current EUR/USD exchange rate is too high and that a depreciation of the EUR against the USD would contribute to relieve the Eurozone economy from the current state of persistent crisis. Evidence provided by the a/simmetrie annual econometric model suggests that this claim is unsupported by the data, at least as far as the Italian economy is concerned. In fact, the size and sign of the trade elasticities show that the increases in net exports towards non-Eurozone countries, brought about by the depreciation of the euro, would be offset by an increase in net imports towards Eurozone countries, brought about by the increase in Italian domestic demand.

And indeed Tyler also assumed that this pessimistic conclusion was their key finding, in his quick summary of the results. But in fact that’s not at all what the paper says. Here’s the key paragraph:

Before presenting the results, it is worth noting that the simulations proposed were performed using only the foreign trade block of the model, supplemented with the national income identity and the price deflators equations. As a consequence, the results presented have only a partial equilibrium meaning and are still preliminary. In particular, they take into account the feedback on imports following from the expansion of aggregate demand caused by the increase in exports, as well as the inflationary effects following from the increase in import prices determined by the nominal exchange rate devaluation, but they do not take into account the “second round” inflationary effects determined via Phillips curve by the decrease in unemployment, which could possibly offset in the longer run the effect of a nominal realignment.

So if you ignore the fact that monetary stimulus that depreciates the euro will also boost NGDP, and that this will boost RGDP and employment via the “Phillips curve” mechanism, and only focus on the fact that a faster growing Italian economy will suck in more imports and hence stimulus will not improve the trade balance, then it appears a weaker euro will not help Italy. And I certainly can’t disagree with that!

However I certainly don’t agree with this:

These results have important policy implications.

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This entry was posted on March 13th, 2015 and is filed under Monetary Theory. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



