Blog Post

On the efficacy of internal devaluations: answers to the questions of Kevin O’Rourke

Kevin O’Rourke kindly drew attention at http://www.irisheconomy.ie/ to my recent Bruegel Policy Contribution titled “Compositional effects on productivity, labour cost and export adjustments” and asked four questions. In my answer I would like to show some charts – but as I cannot post charts at the Irish Economy blog, I post these charts at Bruegel […]

By: Date: June 25, 2012 Topic: Macroeconomic policy

Kevin O’Rourke kindly drew attention at http://www.irisheconomy.ie/ to my recent Bruegel Policy Contribution titled “Compositional effects on productivity, labour cost and export adjustments” and asked four questions. In my answer I would like to show some charts – but as I cannot post charts at the Irish Economy blog, I post these charts at Bruegel Blog.

Question 1: What happens when you calculate a composition-adjusted real exchange rate index for Ireland vis à vis other eurozone members only?

Figure 1 below shows that since 2008Q1, the difference between the developments of the real effective exchange rate (REER) calculated against euro-area partners only and 30 trading partners is not large: the former depreciated by 12 percent, the latter by 14 percent. In both cases the increase in unit labour costs (ULC) of trading partners played a major role, in addition to Irish ULC falls. The nominal effective exchange rate is constant by definition against euro-area partners and had limited role when considering 30 trading partners.

There is a more significant difference between the intra-euro and the total REER when we look at the 2000-2008 period, largely due to the appreciation of the euro from about 2002.

Note that the 30 countries I consider comprise 85 percent of Irish trade. The distribution within these 30 countries is the following: euro-area 39 percent, UK 22 percent, US 23, Japan 7 percent, others 9 percent.

Figure 1: Business sector excluding agriculture, construction and real estate activates: main components of the Irish unit labour costs based real effective exchange rate (using constant weights; 2008Q1=100), 2000Q1-2011Q4


 

Question 2. What happens if you include agriculture in the index? This is an important traded sector in the Irish context.

Question 3. What happens if you do both 1 and 2?

Let me respond to both questions by showing the REER and its components for the agriculture alone (Figure 2). The data looks noisy, yet after a temporary decline in 2008-2009, the REER has appreciated somewhat (just a cumulative 1 percent if we consider 30 trading partners, but 11 percent when considering euro-area partners only). Therefore, for the business sector the cumulative REER depreciation from 2008Q1 to 2011Q4 is somewhat less if agriculture is included, but not much less, because the share of agriculture in the value added of the business sector excluding construction and real estate was only about 2.5 percent.

Figure 2: Agriculture: main components of the Irish unit labour costs based real effective exchange rate (2008Q1=100), 2000Q1-2011Q4

Question 4. One of the most striking graphs in the paper is Figure 2 on p. 6, which shows that while manufacturing value added has risen by 30 percent since the start of 2008 (thanks to what happened in the pharmaceutical sector), gross production has only risen by 5 percent. Can we make further progress in understanding this discrepancy (there are some helpful suggestions in the paper), and what might this tell us about the movement in Irish unit labour costs and real exchange rates since the crisis began?

Unfortunately, I cannot add more observations on the reasons for the discrepancy – and even acknowledge that the four possible explanations listed in my paper were suggested by the Irish economists I thank on the cover page.

But I can highlight that the assessment of this issue is severely hindered by the lack of publicly available data. Ireland is among the few EU countries for which manufacturing sub-sectoral gross value added is available only in current prices, but not in constant prices (I used Eurostat data). Constant price value added data is available only for the total manufacturing industry and therefore one cannot assess the discrepancy between vale added and gross production at the sub-sectoral level.

Deflators may also play a role (the fourth item listed in my paper), which, consequently, also cannot be assessed at the sub-sectoral level. For the total manufacturing Figure 3 compares the deflators of some countries. The deflators of Ireland, Sweden and the UK showed a similar pre-crisis pattern, which very much differed from the euro-area total – but at least Ireland is not unique in this regard (and deflators are certainly impacted by the sub-sectoral composition of manufacturing).

Since 2008Q1 Irish manufacturing prices fell the most and the trend is in line with the pre-crisis trend. In the UK and Sweden the depreciation of the nominal exchange rate may have contributed to the fall in the deflator. And in Sweden the deflator went up recently, in line with the appreciation of the nominal exchange rate.

Understanding the reasons for the developments of the Irish manufacturing deflator – and having data for sub-sectoral deflators – would help a lot in answer Question 4 of Kevin O’Rourke.

Figure 3: Deflator of total manufacturing value added (2008Q1=100), 2000Q1-2011Q4

Finally, since several bloggers commented public sector wages, also asking what happened in southern euro-area members, let me show a chart on this as well. The left-hand panel of Figure 4 suggests that public servants in Ireland are well paid compared to other sectors of the Irish economy, apart from financials. (Btw, Irish real estate agents take home little, at least as reflected in official statistics.) The right hand panel shows that Irish public servants earn much more per hour than their colleagues in southern Europe, yet Ireland has a much higher income per capita as well, which explain at least part of the difference. Public sector wages declined significantly in Greece from the peak in 2009, yet in all four countries public sector wages are broadly at their late 2007 levels.

Figure 4: Hourly labour compensation ( per hour), 2000Q1-2011Q4

Note: hourly labour compensation was calculated as the ratio of total labour compensation to total hours worked, as reported in the national accounts database of Eurostat.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

May
25
14:30

How can we support and restructure firms hit by the COVID-19 crisis?

What are the vulnerabilities and risks in the enterprise sector and how prepared are countries to handle a large-scale restructuring of businesses?

Speakers: Ceyla Pazarbasioglu and Guntram B. Wolff Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

May - Jun
31-1
10:30

MICROPROD Final Event

Final conference of the MICROPROD project

Speakers: Carlo Altomonte, Eric Bartelsman, Marta Bisztray, Italo Colantone, Maria Demertzis, Filippo di Mauro, Wolfhard Kaus, Steffen Müller, Gianluca Santoni, Verena Plümpe, Andrea Roventini, Valerie Smeets, Nicola Viegi, Markus Zimmermann and Javier Miranda Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event
 

Past Event

Past Event

[Cancelled] Shifting taxes in order to achieve green goals

[This event is cancelled until further notice] How could shifting the tax burden from labour to pollution and resources help the EU reach its climate goals?

Speakers: Niclas Poitiers and Femke Groothuis Topic: Green economy, Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 12, 2022
Read about event More on this topic
 

Past Event

Past Event

How are crises changing central bank doctrines?

How is monetary policy evolving in the face of recent crises? With central banks taking on new roles, how accountable are they to democratic institutions?

Speakers: Maria Demertzis, Benoît Coeuré, Pervenche Berès, Hans-Helmut Kotz and Athanasios Orphanides Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 11, 2022
Read article Download PDF More by this author
 

Book/Special report

European governanceInclusive growth

Bruegel annual report 2021

The Bruegel annual report provides a broad overview of the organisation's work in the previous year.

By: Bruegel Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: May 6, 2022
Read article Download PDF
 

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article Download PDF More on this topic
 

Working Paper

The low productivity of European firms: how can policies enhance the allocation of resources?

A summary of the most important policy lessons from research undertaken in the MICROPROD project work package 4, related to the allocation of the factors of production, with a special focus on the weak dynamism of European small and medium-sized enterprises (SMEs).

By: Grégory Claeys, Marie Le Mouel and Giovanni Sgaravatti Topic: Macroeconomic policy Date: April 25, 2022
Read article More on this topic
 

External Publication

What drives implementation of the European Union’s policy recommendations to its member countries?

Article published in the Journal of Economic Policy Reform.

By: Konstantinos Efstathiou and Guntram B. Wolff Topic: Macroeconomic policy Date: April 13, 2022
Read article Download PDF More on this topic More by this author
 

Working Paper

Measuring the intangible economy to address policy challenges

The purpose of the first work package of the MICROPROD project was to improve the firm-level data infrastructure, expand the measurement of intangible assets and enable cross-country analyses of these productivity trends.

By: Marie Le Mouel Topic: Macroeconomic policy Date: April 11, 2022
Read about event More on this topic
 

Past Event

Past Event

Macroeconomic and financial stability in changing times: conversation with Andrew Bailey

Guntram Wolff will be joined in conversation by Andrew Bailey, Governor of the Bank of England.

Speakers: Andrew Bailey and Guntram B. Wolff Topic: Macroeconomic policy Date: March 28, 2022
Read article
 

Opinion

European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Read article More on this topic More by this author
 

Opinion

The week inflation became entrenched

The events that have unfolded since 24 February have solved one dispute: inflation is no longer temporary.

By: Maria Demertzis Topic: Macroeconomic policy Date: March 8, 2022
Load more posts