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How have global shocks impacted the real effective exchange rates of individual euro area countries since the euro's creation?

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  • Bussière, M.
  • Chudik, A.
  • Mehl, A.

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.

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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 336.

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Length: 47 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:bfr:banfra:336

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Postal: Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS
Web page: http://www.banque-france.fr/
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Keywords: Euro; Real Effective Exchange Rates; Weak and Strong Cross Sectional Dependence; High-Dimensional VAR; Identification of Shocks.;

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Cited by:
  1. Alexander Chudik & Hashem Pesaran, 2014. "Theory and Practice of GVAR Modeling," Cambridge Working Papers in Economics 1408, Faculty of Economics, University of Cambridge.
  2. Agnieszka Szczypińska, 2012. "Does the halo effect still hold? Implications for the euro-candidates from the analysis of the EA bond market - the crisis perspective," Working Papers 15, Ministry of Finance in Poland.

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