Contractionary devaluations in Eastern Europe, again
Also known as the continuing case for agnosticism, especially when it comes to small countries. There is actually a paper on this topic (Cowen’s Second Law!), let’s look at the end part:
Currency depreciation is said to stimulate aggregate demand by increasing its net export component. On the other hand, it is said to discourage aggregate supply by increasing cost of imported inputs. The ultimate impact is ambiguous on theoretical grounds. A recent review article reveals that in developing countries, devaluation or real depreciation is indeed contractionary in the short run. In the long run, however, devaluation is neutral in most countries. Emerging economies have received no attention and we try to fill this gap in this paper.
In this paper we consider the experience of nine emerging countries of Belarus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Russia, and Slovak Republic with currency depreciation. Using the bounds testing approach to cointegration and error-correction modeling that distinguishes the short-run effects from the long-run effects, the results turn out to be country specific. In the short run we find that real depreciation is expansionary in Belarus, Latvia, Poland, and Slovak Republic; contractionary in Czech Republic, Estonia, Hungary, and Russia; and has no effect in Lithuania. In almost none of the countries, the short-run effects lasted into the long run.
A few remarks on this:
1. I have read dozens or maybe hundreds of blog discussions about the wage effects of depreciation/devaluation. I can’t recall very many on the input and portfolio effects. I can’t recall any serious assessment of which effects are more import (sorry if I have forgotten your post or didn’t read it). I also don’t see many discussions of whether observed short-run effects persist in the longer run.
2. I am not trying to push the particular conclusion of this paper on you (“Ah, now I understand where Belarus falls!”), rather I wish to indicate that the matter is not so simple as to always favor floating rates. I am myself usually in the floating rate camp, but with far more agnosticism than I usually see when this topic is tossed around these days. Furthermore the growth literature does not in general indicate that simply sticking with a fixed rate offers inferior long-run performance.
3. It is fine to argue that this 2008 paper may not apply to the conditions of 2012. That would again leave us will very little sound basis to go on for assessing 2012, as we would be asserting that the previous evidence no longer is relevant. Such an attitude should not then push us into a dogmatic point of view, one way or the other.
4. In general I worry that the literature on contractionary devaluation does not have clearly defined exogenous events, or good independent measures of how bad the economic situation is in the first place.
5. The people who actually study this topic, if I dare introduce them into this discussion, very often end up believing that country-specific factors are extremely important. This makes “Econ 101” (or is that 306?) discussions of the topic misleading.
6. It is not the fault of any single individual, but overall I find it disconcerting, and not reflecting so favorably on the econ blogosphere, how disconnected this discussion has been from the actual literature.
7. As a good rule of thumb, any time you hear a dogmatic macroeconomic pronouncement in the econ blogosphere, or the assertion that someone else doesn’t know what he or she is talking about, the actual reality is usually far less certain than the view which is being pushed on you.
Either later today or tomorrow I will address some remarks to the latest dust-up over Iceland, but you can take this post as useful background.