A Re-examination of the Exchange Rate Disconnect Puzzle: Evidence from Japanese Firm Level Data

Robert Dekle (), Hyeok Jeong () and Heajin Heidi Ryoo

No 06.46, IEPR Working Papers from Institute of Economic Policy Research (IEPR)

Abstract: The 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.

New Economics Papers: this item is included in nep-cba, nep-ifn, nep-int and nep-sea
Date: 2006-03
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