The Costs to Consumers of a Depreciated Conversion Rate to the Euro

Marques, Luis B (2007): The Costs to Consumers of a Depreciated Conversion Rate to the Euro.

Abstract

This paper measures the welfare cost to consumers of the bloc of Central and Eastern European Countries (CEEC), plus Malta and Cyprus, of choosing a de- preciated conversion rate when joining the European Monetary Union. For this, I present and solve an appropriately calibrated small open economy model where a euro-denominated bond and the equity on a traded goods sector are traded internationally. I show that the cost of depreciating the domestic currency against the euro by 20%, at the time of joining the European Monetary Union, entails a cost of approximately 1.65% in terms of lost lifetime utility (measured in equivalent units of consumption).

• Item Type: MPRA Paper
• Language: English
• Keywords: trade effect, valuation effect, wealth effect, exchange rate
• Subjects: F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F47 - Forecasting and Simulation: Models and Applications; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

References

[1] Backus, David, Patrick J. Kehoe, and Finn Kydland (1994). "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," The American Economic Review 84, pp. 84-103. [2] Blanchard, Olivier, and Francesco Giavazzi (2002). "Current Account Deficits in the Euro Area: The End of the Feldstein-Horioka Puzzle?" Brookings Papers on Economic Activity, 2, pp. 147-186. [3] Bulir, Ales, and Katerina ¸Smidkova (2005). "Exchange Rates in the New EU Aces- sion Countries: What HaveWe Learned from the Forerunners?" IMF Working Paper 05/27. [4] Cardi, Olivier (2007). "Another View of the J-Curve," Macroeconomic Dynamics, 11(2), pp. 153-174. [5] Cocco, Joao, Francisco Gomes, and Pascal Maenhout (2005). "Consumption and Portfolio Choice over the Life Cycle," Review of Financial Studies, 18(2):491-533. [6] Cooley, Thomas F., and Vincenzo Quadrini (2001). "The Costs of Losing Monetary Independence: The Case of Mexico," Journal of Money, Credit and Banking, Vol. 33, No. 2, Part 2: Global Monetary Integration, pp. 370-397. [7] Egert, Balazs, Laszlo Halpern, and Ronald MacDonald (2005). "Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues," The William Davidson Institute Working Paper No. 793. [8] Fagan, Gabriel and Vitor Gaspar (2007). "Adjusting to the euro," ECB Working Paper Series No. 717. [9] Greenwood, Jeremy, Zvi Hercowitz, and Gregory W. Huffman (1988). "Investment, Capacity Utilization, and the Real Business Cycle," The American Economic Review June 1988, 78, 402-417. [10] Hau, Harald, and Helene Rey (2004). "Can Portfolio Rebalancing Explain the Dy- namics of Equity Returns, Equity Flows, and Exchange Rates?", American Eco- nomic Review, 94 (2), pp. 126-133. [11] Judd, Kenneth L. (1998). Numerical Methods in Economics, Cambridge: MIT Press. [12] Lane, Philip R., and Gian Maria Milesi-Ferretti (2006). "Capital Flows to Central and Eastern Europe," IMF Working Paper 06/188. [13] Leonard, Greg, and Alan Stockman (2002). "Current Accounts and Exchange Rates: A New Look at the Evidence," Review of International Economics, 10(3), pp.483- 496. [14] Marques, Luis B. (2007) "Welfare Implications of Exchange Rate Changes," working paper. [15] Mendoza, Enrique (2001). "The Benefits of Dollarization When Stabilization Policy Lacks Credibility and Financial Markets are Imperfect," Journal of Money, Credit, and Banking, Vol. 33, No. 2, pp. 440-474. [16] Mendoza, Enrique G. and Martin Uribe (2000). "Devaluation risk and the business- cycle implications of exchange-rate management," Carnegie-Rochester Conference Series on Public Policy 53, pp. 239-296. [17] Obstfeld, Maurice, and Kenneth Rogoff (2005). "Global current account imbalances and exchange rate adjustments," Brookings Papers on Economic Activity, 1:2005, pp. 67-123. [18] Rahn, Jorg (2003). "Bilateral equilibrium exchange rates of EU accession countries against the euro," Bank of Finland Institute for Economies in Transition Discussion Paper No. 11. [19] Rawdanowicz, Lukasz (2006). "EMU enlargement and the choice of euro conversion rates," in M. Dabrowski and J. Rostowski (eds.) The Eastern Enlargement of Europe, pp. 113-129. [20] Schadler, Susan, Paulo Drummond, Louis Kuijs, Zuzana Murgasova, and Rachel van Elkan (2005). "Adopting the Euro in Central Europe: Challenges of the Next Step in European Integration," IMF Occasional Paper No. 234. [21] Schmitt-Grohe, Stephanie and Martin Uribe (2003). "Closing small open economy models," Journal of International Economics 61, pp. 163-185. [22] Stockman, Alan, and Harris Dellas (1989). "International Portfolio Nondiversification and Exchange Rate Variability," Journal of International Economics, 26, pp. 271-289. [23] Stokey, Nancy, and Robert E. Lucas (1989). Recursive Methods in Economic Dynamics, Cambridge: Harvard University Press. [24] Swann, Christopher (2002). "Global Investing: Expanding the eurozone may not contract the currency," Financial Times, October 24, 2002. [25] Tille, Cedric (2005). "Financial Integration and the Wealth Effect of Exchange Rate Fluctuations," Staff Report no. 226, Federal Reserve Bank of New York.