Productivity, External Balance and Exchange Rates: Evidence on the Transmission Mechanism among G7 Countries
Title: Productivity, External Balance and Exchange Rates: Evidence on the Transmission Mechanism among G7 Countries
Series/Report no.: EUI ECO; 2006/39
This paper investigates the international transmission of productivity shocks in a sample of ve 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 mech- anism 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 ac- count 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.
Subject: F32; F41; F42; International transmission mechanism; net exports; terms of trade; real exchange rates; VAR; long-run restrictions; US current account
Type of Access: openAccess