Productivity, External Balance and Exchange Rates: Evidence on the Transmission Mechanism Among G7 Countries

67 Pages Posted: 4 Oct 2006 Last revised: 12 Aug 2010

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Luca Dedola

Bank of Italy; European Central Bank (ECB)

Sylvain Leduc

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Multiple version iconThere are 2 versions of this paper

Date Written: August 2006

Abstract

This paper investigates the international transmission of productivity shocks in a sample of five G7 countries. For each country, using long-run restrictions, we identify shocks that increase permanently domestic labor productivity in manufacturing (our measure of tradables) relative to an aggregate of other industrial countries including the rest of the G7. We find that, consistent with standard theory, these shocks raise relative consumption, deteriorate net exports, and raise the relative price of nontradables --- in full accord with the Harrod-Balassa-Samuelson hypothesis. Moreover, the deterioration of the external account is fairly persistent, especially for the US. The response of the real exchange rate and (our proxy for) the terms of trade differs across countries: while both relative prices depreciate in Italy and the UK (smaller and more open economies), they appreciate in the US and Japan (the largest and least open economies in our sample); results are however inconclusive for Germany. These findings question a common view in the literature, that a country's terms of trade fall when its output grows, thus providing a mechanism to contain differences in national wealth when productivity levels do not converge. They enhance our understanding of important episodes such as the strong real appreciation of the dollar as the US productivity growth accelerated in the second half of the 1990s. They also provide an empirical contribution to the current debate on the adjustment of the US current account position. Contrary to widespread presumptions, productivity growth in the US tradable sector does not necessarily improve the US trade deficit, nor deteriorate the US terms of trade, at least in the short and medium run.

Suggested Citation

Corsetti, Giancarlo and Dedola, Luca and Leduc, Sylvain, Productivity, External Balance and Exchange Rates: Evidence on the Transmission Mechanism Among G7 Countries (August 2006). NBER Working Paper No. w12483. Available at SSRN: https://ssrn.com/abstract=926513

Giancarlo Corsetti (Contact Author)

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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Luca Dedola

Bank of Italy ( email )

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European Central Bank (ECB) ( email )

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Sylvain Leduc

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

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San Francisco, CA 94105
United States

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