Guest Post: Half a century of large currency appreciations – Did they reduce imbalances and output?

By Marcus Kappler, Helmut Reisen, Moritz Schularick, and Edouard Turkisch. Cross posted from VoxEU.

If China only allowed its currency to appreciate, the global economy would rebalance and stabilise – or so the argument goes. This column studies the historical record of large exchange-rate revaluations. It supports the idea that currency appreciations have an impact on the current account but argues that this can come at a cost – the reduction in exports risks putting the brakes on global growth.

Over the past decade, several emerging market economies – China in particular – have run substantial and persistent current-account surpluses. Loose monetary policy in the US could now result in higher domestic inflation within these emerging economies and lead to the sort of real currency appreciation that many countries want to avoid (Bergsten 2010 and Huang 2010).

It is well known that countries must choose between capital mobility, monetary policy autonomy, and exchange-rate stability but cannot pursue all three objectives at the same time. Clearly, China’s authorities are increasingly forced to consider currency appreciation as they fear the social ramifications of rising prices. From a global perspective, current-account imbalances and reserve accumulation may have contributed to the mispricing of risk and helped create the macroeconomic backdrop for the recent financial crisis. Currency appreciations in surplus countries could be a policy tool in reducing imbalances (Ferguson and Schularick 2011).

Yet currency appreciation remains a controversial policy choice among economists. In recent research (Kappler et al. 2011), we use a large cross-country dataset covering almost 50 years of international economic history between 1960 and 2008 to study the empirical record of large exchange-rate appreciation and revaluation episodes. Some of these episodes are regularly referred to in the debate about global rebalancing in the wake of the recent financial crisis, e.g. in Germany and in Japan.

The main points of disagreement about the effects of exchange-rate changes on the macroeconomy relate to two central issues.

First, how effective would currency revaluation be in reducing current-account surpluses in Asia and deficits in the US? Unless structural saving and investment determinants change, there will be no change in current-account imbalances (Qiao 2007).

Second, is there reason to believe that appreciation would come with the negative side effect of reducing growth in developing countries? Appreciation might put a successful export-led growth model at risk. This model was centred on a competitive real exchange rate and positive externalities from investment in the tradable goods sector. Some economists fear that exchange-rate adjustment might be all too effective – but mainly in reducing the growth rate of the Chinese as well as other developing economies because China has become a locomotive for developing country growth in the 2000s (Garroway et al. 2010).

Digging up the historical evidence

While these questions open up a number of different conceptual issues, they are to some degree open to a joint empirical treatment. We define large exchange-rate events as a 10% (or larger) appreciation of the nominal effective exchange rate over a two-year window (or less), leading to sustained real effective appreciation of the same magnitude, sustained in real terms over at least five years. From 1960, we identify 25 episodes of large nominal and real appreciations and revaluations in a sample of 128 countries of developing and advanced economies. Studying the institutional context of each individual episode in detail, we find 14 cases of appreciation shocks that occurred not as a result of discretionary policy action, but were linked to the appreciation of the anchor currency under pegged exchange rates. These cases represent exogenous appreciation shocks that can be used to estimate the macroeconomic impact of large appreciations and assess the robustness of estimates based on a wider definition of appreciation and revaluation events.

We use a dummy-augmented autoregressive panel model (as in Cerra and Saxena 2008) to show that such large appreciations episodes have strong macroeconomic effects. The estimated effects of appreciation shocks on key macroeconomic variables are shown in the appendix. Four key stylised facts emerge that may well prove useful in the ongoing debate about the role of exchange-rate adjustment for global rebalancing.

First, the current-account balance typically falls strongly in response to large exchange-rate revaluations. Three years after the revaluation, the current account balance deteriorates by about 3 percentage points relative to GDP. This is due to a reduction in aggregate savings without a concomitant fall in investment. The effect on the current-account balance is statistically significant and robust to variation in the country sample and the definition of appreciation events.

Second, the effects on output seem limited. The point estimates suggest a negative effect of output growth, albeit of relatively small magnitude. On average, the aggregate level effect on output amounts to about 1% after six years. However, the output effects are statistically not significant.

Third, while aggregate output is not strongly affected, export growth falls significantly after appreciation shocks. Import growth remains by and large unchanged resulting in the observed deterioration in external balances. As aggregate economic growth is much less affected, these results point to a positive domestic demand response following appreciation episodes.

Fourth, the effects seem to be more pronounced in developing countries. The sensitivity of the current-account balance to revaluation shocks is higher. The effect reaches almost 4 percentage points of GDP after three years and is statistically significant. But also the potentially negative effects on output are larger, pointing to a loss in output of 2% over 10 years, albeit with wide confidence intervals.


The historical record of large exchange-rate revaluations that we have studied lends support to the idea that they have an impact on the current account as they lead to marked changes of savings and investment within countries. Appreciation shocks impact external balances, but this effect potentially comes at the cost of a reduction of dynamism in exports. While the domestic economy seems to pick up some of the external slack, leaving overall growth relatively unaffected, the prospect of sharp decelerations in export growth will remain a concern for policymakers and warrants careful attention especially in the context of developing countries.

Print Friendly, PDF & Email


  1. MyLessThanPrimeBeef

    From the second fact –

    If the US currency should have gone down 10% over a two year span 6 years ago, had they not manipulated it, we would not have lost that 1% output, on average, though not statistically signinficant.

    And we will lose another 1% in output, on average, though not statistically significant, in about 6 years, if another 10% adjustment doesn’t occur over a two year span, when, without manipulation, it should.

    But if there is a 10% reevaluation in an emerging market currency, that country will lose 2% in output in 10 years, with wide confidence intervals.

    And it’s better to lose 1% in output in 6 years for the biggest economy of the globe than 2% in output in 10 years for some emerging market nation. Right?

    On an absolute scale, it might work if that emerging market GDP is at least 50% of ours, if you forget about the difference between 6 and 10 years.

    You can also say that losing 1% when we (America) are only growing at 2% per year is 50% reduction in growth, while losing 2% when that emerging market country is growing at 8% is a mere 25% reduction in her growth rate.

  2. Paul Repstock

    Currency manipulations, be they appreciative or depreciative are undertaken as policy tools. The disingenuous “Strong Dollar” policy of the American government over the past years has had several purposes. I suspect that cheif amoung them is to facilitate the repatriation of huge amounts of US Dollar cash held in foreign hands: read the “mystery of the missing currency”, half way down.

    I suspect that the second part of this ‘reverse Strong Dollar Policy’, is directed at the American People. The recent commodity binge combined with the falling dollar is increasingly presuring the ability of ordinary people to afford basic necesities. In the current economic climate there is no chance of wage increases keeping pace with inflation, unless one is employed in prime government position like DHS or Airport security. This type of leverage strengthens the government position.

  3. F. Beard

    One of the problems with a government enforced monopoly money supply is that monetary policy cannot be tailored properly (not to mention ethically). For instance, a company that imports a lot might desire a strong dollar while a company that exports a lot might desire a weak dollar. How can both desires be accommodated with a single, government enforced monopoly money supply? They can’t.

    The solution was hinted at 2000 years ago by Matthew 22:16-22: separate government and private money supplies. That way, each individual corporation could issue its own private money as much or as little as was desired.

    All of us, including those dependent on government, would benefit from liberty in private money creation.

  4. Richard Kline

    If your currency goes up, you can buy more without having to sell more (or as much). And you spend more on yourself. . . . I’ll ‘buy’ that. But it’s good to have the empirical foundation for the observation, so I appreciate the study.

    And Paul Repstock, the ‘strong currency’ program has a history of several millennia. It’s a political tool even before it’s an economic tool, though separating the two processes is more a conceptual error than an analytic advantage. Other people want your coin, and that makes them a bit dependent on you for access to it. And the solidity of your coin makes it a more effective force multiplier when applied at a given point/issue, like a fulcrum of iron is better than one of wood for many things. It’s a confidence stimulant too, a doping agent of a kind. Having the most liquid and strongest currency is a huge advantage in military-political pinches too: you can buy friends, or at least more of them than the other side. There are other issues, but those are to the fore.

    All these considerations for a strong currency are in play before we get to more ‘strategic’ concerns such as you consider. Typically, you need either a strong economy or a reliable wealth-extraction gradinent with an external population (i.e. ‘tribute’) to have a strong currency. Developing industrial economies late 20th – early 21st century seldom have these capacities, so they face different choices until and unless they acquire them. Possessing a major commodity resource can in principal give you a strong currency, except that commodity prices are not notably stable which can be a _big_ problem for commodity extractors. The best bet for a strong currency is a large, diverse domestic production economy because domestic demand can be used to buffer external shifts. I mention all this because the most fundamental issue for China’s changing economy has been the underdevelopment of its domestic economy. That has left them until the last few years less able to use domestic production to underwrite a strong currency. Raising their currency with an underweight domestic sector would stiffle domestic development subsequently in many respects. Of course, presently we have an over-shoot of Chinese domestic investment in production (or ‘production’ given the _unproductive_ use of some capital development there). But we’ll see China’s currency rise when it is felt that the domestic economy there has passed the threshold of sustainable robustness of demand (or whatever you want to call the process). Compiling huge stacks of US $ denominated assets has been a largely unintended and enormous headache in the larger goal from where I watch the process, but the eyes and ayes there are on the prize, getting the knowledge base, technology transfer, and productive output sectors in place.

  5. Hugh

    “From a global perspective, current-account imbalances and reserve accumulation may have contributed to the mispricing of risk and helped create the macroeconomic backdrop for the recent financial crisis.”

    Isn’t this just a repetition of the charge made by Bernanke I believe that the meltdown was really the fault of the Chinese? Good to know that synthetic CDOs, bubbles, casino capitalism, and fraud had so little to do with it, from a global perspective naturally speaking of course.

  6. Don

    It certainly seems logical to me that a stronger currency would have slowed the rapid growth of China, or other heavily exporting nations. But if that rapid growth is being realized at a penalty to other nation’s growth, or to the exporter’s domestic consumers, then perhaps the slower growth/stronger currency scenario is not all bad, -and maybe even superior.

    It seems to me that we have not yet felt the full negative effects of excessive U.S. consumption and excessive Chinese exports, to take just one example.

    Too rapid growth, like too rapid speeding on a highway, can- & will- result in unexpected and unwanted consequences.

  7. FullFrontal PatDown

    mispricing of risk and helped create the macroeconomic backdrop for the recent financial crisis. Currency appreciations in surplus countries could be a policy tool

    Tell me something? Is the propping up of foreign currency at the expense of trashing your own currency orchestrated for the purpose of snaking the foreign customer of your finished goods? No! It instead implies the intent of snaking your competitors to gain more market share, to gain more of customers at the expense and sadness of your hopeful competition. When Chinese effectively drop their export prices through currency manipulation they are not hurting America, they are hurting Japanese, Koreans, and Australians. When Wal★Mart offers “always the low price” they do not offer with intent to snake their customers. By contrast they are subsidizing their customers but snaking Wal★Green, Tar★Get, and Tar★Heel Competitors.

    Don’t get paranoid, Loyd! Get bargains!

    How low can you go, prices?

    Get down

    1. alex

      “It instead implies the intent of snaking your competitors to gain more market share, to gain more of customers at the expense and sadness of your hopeful competition. When Chinese effectively drop their export prices through currency manipulation they are not hurting America, they are hurting Japanese, Koreans, and Australians.”

      You’re making at least two incorrect assumptions:

      1) Americans are strictly consumers, and the Chinese, Japanese, Koreans, and Australians are strictly producers. But obviously all of those peoples are both producers and consumers, so what helps us as consumers hurts us as producers, and vice versa for the other peoples.

      2) That the US has balanced trade. Were that so, we would be getting bargains, but with our current account deficit, which is in large part a result of currency manipulation, we may be buying cheap but we’re buying with borrowed money. With a big enough credit card any country can live well for a while, but creditors eventually expect to get paid back.

Comments are closed.