How Have Global Shocks Impacted the Real Effective Exchange Rates of Individual Euro Area Countries Since the Euro's Creation?

47 Pages Posted: 30 Jul 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: July 2011

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.

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, How Have Global Shocks Impacted the Real Effective Exchange Rates of Individual Euro Area Countries Since the Euro's Creation? (July 2011). Banque de France Working Paper No. 336. Available at SSRN: https://ssrn.com/abstract=1898554 or http://dx.doi.org/10.2139/ssrn.1898554

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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