Exchange Rates, the Competitiveness of Nations and Unemployment
Pedro Bação, António Portugal Duarte & Diana Machado
The main goal of this paper is to assess the impact of exchange rate fluctuations on economic activity, namely on unemployment. We estimate a Vector Autoregressive (VAR) model for each of the following major economies: Australia, Brazil, China, Germany, Japan, Switzerland, the United Kingdom and the United States of America. The VAR model comprises the following variables: the unemployment rate, the GDP growth rate, the inflation rate, the interest rate, and the real effective exchange rate. We use the Cholesky decomposition to identify the shocks that drive these variables. The results obtained using the Cholesky decomposition depend on the ordering of the variables; therefore we discuss the results obtained when different orderings are employed. Our results suggest that an exchange rate appreciation leads to an increase in unemployment in relatively small countries such as Australia, Switzerland and the UK, but not in Japan or in the USA. The results for Brazil, China and Germany do not appear to be satisfactory, possibly because the sample covers a period of important structural change in those countries.
Keywords: Competitiveness, currency wars, exchange rate, monetary policy, unemployment, VAR model
JEL classification: F16, F31, F41