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Estimating the effect of exchange rate changes on total exports

Thierry Mayer () and Walter Steingress ()

No 786, BIS Working Papers from Bank for International Settlements

Abstract: This paper shows that real effective exchange rate (REER) regressions, the standard approach for estimating the response of aggregate exports to exchange rate changes, imply biased estimates of the underlying elasticities. We provide a new aggregate regression specification that is consistent with bilateral trade flows micro-founded by the gravity equation. This theory-consistent aggregation leads to unbiased estimates when prices are set in an international currency as postulated by the dominant currency paradigm. We use Monte-Carlo simulations to compare elasticity estimates based on this new "ideal-REER" regression against typical regression specifications found in the REER literature. The results show that the biases are small (around 1 percent) for the exchange rate and large (around 10 percent) for the demand elasticity. We find empirical support for this prediction from annual trade flow data. The difference between elasticities estimated on the bilateral and the aggregate levels reduce significantly when applying an ideal-REER regression rather than a standard REER approach.

Keywords: trade elasticity; real effective exchange rate; gravity equation; dominant currency paradigm; aggregation bias (search for similar items in EconPapers)
JEL-codes: F11 F12 F31 F32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-int, nep-mon and nep-opm
Date: 2019-05
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Related works:
Working Paper: Estimating the Effect of Exchange Rate Changes on Total Exports (2019) Downloads
Working Paper: Estimating the Effect of Exchange Rate Changes on Total Exports (2019) Downloads
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