DP10203 Real Exchange Rates and Sectoral Productivity in the Eurozone

Author(s): Martin Berka, Michael B Devereux, Charles M Engel
Publication Date: October 2014
Keyword(s): Balassa-Samuelson, Eurozone, Real Exchange Rates, Total Factor Productivity, Unit Labor Cost
JEL(s): F31, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10203

We investigate the link between real exchange rates and sectoral total factor productivity measures for countries in the Eurozone. Real exchange rate patterns closely accord with an amended Balassa-Samuelson interpretation, both in cross-section and time series. We construct a sticky price dynamic general equilibrium model to generate a cross-section and time series of real exchange rates that can be directly compared to the data. Under the assumption of a common currency, estimates from simulated regressions are very similar to the empirical estimates for the Eurozone. Our findings contrast with previous studies that have found little relationship between productivity levels and the real exchange rate among high-income countries, but those studies have included country pairs which have a floating nominal exchange rate.