16.1: Real Exchange Rates and the Current Account
In 1992, Britain and Italy devalued their currencies relative to the German mark, causing the
European Monetary System to partially break up. If the purchasing power of a currency decreases,
economists say that the current account should increase, as imports become more expensive and
exports become less expensive. Find the CPI as a measure of prices, exchange rates, and current
account balances for Germany, Italy, and the United Kingdom from 1989-1995. Did the devaluations
result in a substantial decrease in the purchasing power of the currencies? Was there a substantial
effect on the current account?
Data: For the CPI, go to the Economagic webpage at http://www.economagic.com/blsint.htm. For
exchange rates, go to the Federal Reserve System webpage at
http://research.stlouisfed.org/fred2/categories/15. Exchange rates between the European
currencies can be calculated by using two European currency/U.S. dollar exchange rates.
Current account data are available in the file currentacct.xls that was generously provided by
the International Monetary Fund. The current account data are quarterly, so you will need to create
a quarterly average of the real exchange rates.
16.2: Changes in Money Supply, Production, and the Exchange Rate
When the United Kingdom and Italy devalued their currencies in 1992, their domestic money supplies
should have increased and, according to Figure 16-14, domestic production should have risen. But
to what degree did the money supplies and production levels really rise as the real values of
domestic currencies decreased?
Data: For the CPI, go to the Economagic webpage at http://www.economagic.com/blsint.htm. For
exchange rates, go to the Federal Reserve System webpage at
http://research.stlouisfed.org/fred2/categories/15. Exchange rates between the European
currencies can be calculated by using two European currency/U.S. dollar exchange rates.
Money supply and production （as well as price and exchange rate） data are available in the file
macromonthly.xls that was generously provided by the International Monetary Fund. The production
data are quarterly, so you will need to create a quarterly average of the real exchange rates.
16.3: Fiscal Expansions
Figure 16-11 shows that a temporary fiscal expansion should cause the domestic currency to
appreciate and domestic production to increase. Look at data on the fiscal deficit, the exchange
rate, and national income in the U.S. from 1980-2007. Are the data consistent with this simple
prediction? Changes in interest rates may have occurred as well, which would be represented as
a shift in the AA curve. （See Figure 16-10.）
Data:The Federal Reserve System has data on the federal deficit at
http://research.stlouisfed.org/fred/data/business/fyfsd, data on exchange rates at
http://research.stlouisfed.org/fred/data/exchange/twexmmth, and data on interest rates at
http://research.stlouisfed.org/fred/data/irates/tb3ms. For the preceding data, create annual
averages and calculate the growth rates of these averages. Note also that exchange rates are
defined by the FRS so that an increase in the rate indicates an appreciation of the U.S. dollar.
The Federal Reserve System also has data for GDP at
http://research.stlouisfed.org/fred2/categories/18. These data are reported each quarter, but
are annualized, so you can calculate annual growth rates using the first quarter data of each
year.
16.4: Real Exchange Rates and the Current Account
A trade-weighted exchange rate index is intended to show the changes in the value of a country's
currency relative to all of the currencies that are used when the country trades. Look at the
trade-weighted exchange rate index for the U.S. dollar and the U.S. current account from 1980-2007.
What is the relationship between the current account and the trade-weighted exchange rate index?
Do you see evidence of a J-curve when the dollar depreciates?
Data: The Federal Reserve System provides a trade-weighted exchange rate index at
http://research.stlouisfed.org/fred/data/exchange/twexmmth and current account data at
http://research.stlouisfed.org/fred/data/exchange/bopbca. The current account data are
quarterly, so you will need to average the monthly exchange rate data.
16.5: Exchange Rates and the Terms of Trade
The text discusses the fact that firms sometimes set different prices in different markets to
maximize profit and sometimes have different currency invoicing in different countries, so that
the prices of imports and exports may not always immediately change when exchange rates change.
Some have hypothesized that a country's terms of trade could improve when its currency depreciates.
You can test this hypothesis by examining the trade-weighted exchange rate index versus the terms
of trade from 1989-present. Use the help function in a spreadsheet or statistical software program
to calculate the correlation coefficient of these two measures. Is it positive or negative? Note:
the trade-weighted exchange rate index is defined so that an increase represents an appreciation
of the domestic currency, unlike in the textbook.
Data: Import and export prices for the terms of trade are available from the Bureau of Labor
Statistics at http://www.bls.gov/web/ximpim.supp.toc.htm. Select Table 1 and Table 2. The
trade-weighted exchange rate index is available from the Federal Reserve System at
http://research.stlouisfed.org/fred/data/exchange/twexmmth.