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
Date Written: February 3, 2011
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: Suggested Citation