A Re-examination of the Exchange Rate Disconnect Puzzle: Evidence from Japanese Firm Level Data
AbstractThe empirical literature examining aggregate data has generally found small or insignificant effects of exchange rate fluctuations on export volumes. This lack of association between real quantities, such as export volumes and the exchange rate is the so-called “exchange rate disconnect puzzle.” Using firm level data, however, the relationship between export volumes and exchange rates turns to significantly negative. This paper attempts to reconcile these aggregate and firm level findings, using firm level data from Japan. We estimate a simple microeconomic model of exports to show that an appreciation of the exchange rate reduces export volumes at the firm level. After consistent aggregation, the relationship still remains significant at aggregate levels. However, we show that the omission of some key productivity variables, or ignoring the distributions of heterogeneous firm level characteristics biases the elasticity of exports to exchange rates toward zero.
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Bibliographic InfoPaper provided by Institute of Economic Policy Research (IEPR) in its series IEPR Working Papers with number 06.46.
Length: 43 pages
Date of creation: Mar 2006
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-05-07 (All new papers)
- NEP-CBA-2006-05-08 (Central Banking)
- NEP-IFN-2006-05-23 (International Finance)
- NEP-INT-2006-05-07 (International Trade)
- NEP-SEA-2006-05-17 (South East Asia)
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