The divergent prospects for growth, interest rates and monetary policies between the euro zone and the United States has led to a completely normal depreciation of the euro against the dollar, despite this depreciation being limited by the euro zone’s external surplus. Most observers are exuberant about this depreciation of the euro, but Natixis asks, [6] faced with imports that the euro zone cannot do without (commodities, components manufactured outside the euro zone due to the segmentation of production processes), is it certain that it has a positive effect on euro-zone growth? Given the sensitivity of the euro zone's foreign trade (in volume terms and in terms of prices) to the euro's exchange rate, and at the historical link between the relative growth of the euro zone and the euro’s exchange rate, Natixis [6] (devastatingly for the recovery-enthusiasts) find that the effect of a depreciation of the euro on euro-zone growth is very minor at best and, at worst, zero.
Via Natixis, [6]
Normal depreciation of the euro
The outlook for growth in the euro zone is much less bright than in the United States (Chart 1, Table 1). This has led to prospects for much higher interest rates – both short- and long-term – in the United States than in the euro zone (Charts 2A and B and 3A, B and C).
[7]
Despite the euro zone’s external surplus (Chart 4A), linked to the weakness of its domestic demand (Chart 4B), this outlook for a more restrictive monetary policy in the United States points to a gradual depreciation of the euro (Charts 5A and B), curbed by the surplus in the euro zone’s current-account balance and by the role of the euro as an international reserve currency sought by central banks (Chart 6), which results in purchases of euro-denominated bonds by non-residents.
[8]
Most analysts and politicians are pleased about this prospect of a depreciation of the euro. But is it certain that a depreciation of the euro leads to more growth in the euro zone?
Euro exchange rate and euro-zone growth
So we are trying to determine whether a weaker euro leads to stronger growth in the euro zone. The doubt stems from imports that the euro zone cannot do without:
- Commodities (Chart 7A), which represent 6 percentage points of GDP;
- Components imported from the rest of the world due to the international segmentation of value chains (Chart 7B).
[9]
We will use two approaches:
- Estimated elasticities of foreign trade to the exchange rate;
- The observed historical relationship between the relative growth of the euro zone and the euro’s exchange rate.
1. Elasticity of foreign trade to the exchange rate
We estimate econometrically:
- The elasticity of the euro zone’s exports in volume terms to the euro’s real trade-weighted exchange rate (Chart 8A);
- The elasticity of the price of euro-zone exports to the euro’s nominal trade-weighted exchange rate (Chart 8B);
- The elasticity of the euro zone’s imports in volume terms to the euro’s real trade-weighted exchange rate (Chart 8C);
- The elasticity of the price of euro-zone imports to the euro’s nominal trade-weighted exchange rate (Chart 8D);
[10]
We obtain:
- Elasticity of exports in volume terms to the real exchange rate (an appreciation is a rise in the exchange rate): -0.15;
- Elasticity of the price of exports to the nominal exchange rate: -0.27;
- Elasticity of imports in volume terms to the real exchange rate: +0.05;
- Elasticity of the price of imports to the nominal exchange rate: -0.36.
* * *
A 10% depreciation of the euro:
- Increases euro-zone exports by 4.2% (given the increase in their relative price);
- Increases euro-zone imports by 3.1% (given their relative price);
- Therefore increases the euro zone’s level of GDP by only 0.2 percentage point.
* * *
2. Historical relationship between the relative growth of the euro zone and the euro’s exchange rate
We look at the link between growth in the euro zone relative to the United States and to the world (Chart 9A) and the euro’s exchange rate. Chart 9B shows that growth in the euro zone relative to the United States was high in 2001 (with a weak euro) but also in 2006-2007 (with a strong euro), and then declined while the euro depreciated. Chart 9C shows that growth in the euro zone relative to the world fell from 2001 to 2003 (with a weak euro) and has since been stable. We see no link between the relative growth of the euro zone and the euro’s exchange rate.
[11]
Conclusion: Should we be thrilled about the euro’s depreciation?
The divergent prospects for growth and interest rates between the United States and the euro zone explain the euro’s depreciation despite the euro zone’s external surplus. Is the euro’s depreciation good news if we take into account the weight of the euro zone’s necessary imports? First we looked at the elasticities of euro-zone export and import volumes and prices to the exchange rate. We saw a slightly positive effect of the euro’s depreciation on real GDP in the euro zone. Next we looked at the link between euro-zone growth relative to the United States and the world and the euro’s exchange rate. It appears no such link exists.
