Does the Euro Make a Difference? Spatio-Temporal Transmission of Global Shocks to Real Effective Exchange Rates in an Infinite VAR

55 Pages Posted: 13 Feb 2011

See all articles by Matthieu Bussière

Matthieu Bussière

Banque de France

Alexander Chudik

Federal Reserve Banks - Federal Reserve Bank of Dallas

Arnaud Mehl

European Central Bank (ECB)

Date Written: February 3, 2011

Abstract

This paper provides evidence on whether the creation of the euro has changed the way global turbulences affect euro area and other economies. Specifically, it considers the impact of global shocks on the competitiveness of individual euro area countries and assesses whether their responses to such shocks have converged, as well as to what pattern. Technically, the paper applies a newly developed methodology based on infinite VAR theory featuring a dominant unit to a large set of over 60 countries' real effective exchange rates, including those of the individual euro area economies, and compares impulse response functions to the estimated systems before and after EMU with respect to three types of shocks: a global US dollar shock, generalised impulse response function shocks and a global shock to risk aversion. Our results show that the way euro area countries' real effective exchange rates adjust to these shocks has converged indeed, albeit to a pattern that depends crucially on the nature of the shock. This result is noteworthy given the apparent divergence in competitiveness indicators of these countries in the first ten years of EMU, which suggests that this diverging pattern is unlikely to be due to global external shocks with asymmetric effects but rather to other factors, such as country-specific domestic shocks.

Keywords: Euro, Real Effective Exchange Rates, Weak and Strong Cross Sectional Dependence, High-Dimensional VAR, Identification of Shocks

JEL Classification: C21, C23

Suggested Citation

Bussiere, Matthieu and Chudik, Alexander and Mehl, Arnaud, Does the Euro Make a Difference? Spatio-Temporal Transmission of Global Shocks to Real Effective Exchange Rates in an Infinite VAR (February 3, 2011). ECB Working Paper No. 1292. Available at SSRN: https://ssrn.com/abstract=1754464

Matthieu Bussiere (Contact Author)

Banque de France ( email )

Paris
France

Alexander Chudik

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Arnaud Mehl

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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