The Macroeconomic Consequences of Exchange Rate Depreciations

Research Question

How does an exchange rate depreciation causally affect macroeconomic outcomes? The paper asks whether depreciations are expansionary or contractionary, and through which mechanism. The core identification challenge is endogeneity: exchange rate changes are driven by shocks that simultaneously affect output, making causal inference from unconditional variation misleading.

Empirical Strategy

The paper studies “regime-induced” exchange rate depreciations by comparing macroeconomic outcomes for countries that peg their currency to the US dollar versus countries whose currencies float against the US dollar, in response to movements in the US dollar’s value. The identifying variation arises from the interaction between a country’s pre-existing exchange rate regime (peg vs. float) and changes in the US dollar’s nominal effective exchange rate (NEER), as measured by the BIS trade-weighted index against 24 relatively advanced economies (which are excluded from the analysis). This variation — which amounts to roughly 8% of total exchange rate variation in the sample — isolates a component of bilateral exchange rate changes that is orthogonal to idiosyncratic domestic shocks. The empirical specification is a local projection (Jorda, 2005) on annual data from 1973 to 2019 with country fixed effects and region-by-time fixed effects (four regions: Europe, Americas, Africa, Asia/Oceania). The main estimating equation regresses cumulative changes in outcome variables on the interaction term Peg × ΔUSD at horizons h = 0 to 9. Standard errors are two-way clustered by time and country. Exchange rate regime classification follows Ilzetzki, Reinhart, and Rogoff (2019); observations classified in the most ambiguous intermediate categories (coarse category 3) are dropped from the baseline.

Masao Fukui | Macro Paper Warehouse

The Macroeconomic Consequences of Exchange Rate Depreciations