Real Exchange Rate Volatility, Economic Growth and the Euro

Real Exchange Rate Volatility, Economic Growth and the Euro

This paper studies the impact of real effective exchange rate volatility on economic growth as well as the euro’s impact on real effective exchange rate volatility. We first show that after a plausible endogeneity correction, real effective exchange rate volatility is negatively associated with growth in a 1980~2011 panel of the OECD (Organization for Economic Cooperation and Development) countries. A one standard deviation volatility decrease is associated with a two percentage points growth increase. Second, we find that the euro adoption was associated with a decline of 0.4 standard deviations in long-run real effective exchange rate volatility before the Great Recession in 2008~2009. Moreover, while the Great Recession increased real effective exchange rate volatility by 38~189% of the sample mean for the countries outside the eurozone, the real effective exchange rate of the euro adopters were almost completely insulated. We conclude that real effective exchange rate stability may be growth-enhancing in the OECD countries and that the euro have played a growth-enhancing role at least before the recent eurozone debt crisis.