Depreciate to save the economy? An empirical evidence worldwide

• DOI: http://doi.org/10.1002/ijfe.1864
• Date: 01 January 2021
• Published date: 01 January 2021
• Author: Chen Ku‐Hsieh

RESEARCH ARTICLE

Depreciate to save the economy? An empirical evidence

worldwide

Chen Ku-Hsieh

Department of Applied Economics and

Management, National Ilan University,

Yilan, Taiwan

Correspondence

Chen Ku-Hsieh, Department of Applied

Economics and Management, National

Ilan University, Yilan, Taiwan.

Email: khchen@niu.edu.tw

Abstract

Can depreciation save the economy? This paper conducts an empirical exami-

nation with balanced panel data for 133 economies from 1980 to 2014. In the

study, the impact of depreciation is dichotomized into common effect and indi-

vidual effect. The results show that, first of all, the common effect is negative

in the current period, and turns to be positive in the lag period, while the mag-

nitude of the former is higher. Secondly, it is also revealed that in terms of

individual effect, the negative impact of the common effect will be intensified

by the degree of openness, but be mitigated by the scale, floatability, and devel-

opment level of economies. Among them, scale has a decisive influence. Third,

when putting the two tiers of effects together, the aggregate results are gener-

ally not strong; moreover, only a few economies can benefit from depreciation.

The exceptions are the US and China, which can obtain approximately 0.58%

benefits from a 1% depreciation. Fourth, insufficient evidence was found to

show a contribution of exchange rate change to total factor productivity. Fifth,

there is a two-way causal relationship between exchange rate and output; how-

ever, the causality between exchange rate and productivity is not obvious.

KEYWORDS

exchange rate, income growth, productivity change

JEL CLASSIFICATION

C32; F31; F37; F43

1|INTRODUCTION

Depreciate to save the economy! Such a plausible proposi-

tion prevails over the minds of people, industries, and even

monetary authorities worldwide as a policy measure and

expectation. It is presumed that depreciation in the foreign

exchange rate would be helpful in terms of the price advan-

tage of export goods externally and harmful to the price

competitiveness of import goods internally for an economy,

while the purpose of output growth could be reached. A

recent well-known case is the “three arrows”shot by

Sihnzo Abe, the prime Minister of Japan, in December

2012. The first arrow was just an attempt to expand exports

by lowering the exchange rate of the Yen and doubling up

the quantity of currency (Economist, 2014). Likewise, to

rescue a weak economy, the European Central Bank initi-

ated a European version of quantitative easing in March

2015. It was intended to promote exports with depreciation

by bond purchase and vast euro injection into the market

(Economist, 2015). Moreover, in Taiwan, in order to salvage

thefeebleincomegrowththathadplungedbyalmosthalf,

scholars and enterprises appealed to the government for

depreciation to ease up the pressure from trade competitors

(Luo, Tsou, Luo, & Luo, 2013).

Received: 30 November 2018 Revised: 10 October 2019 Accepted: 18 June 2020

DOI: 10.1002/ijfe.1864

Int J Fin Econ. 2021;26:1563–1585. wileyonlinelibrary.com/journal/ijfe © 2020 John Wiley & Sons Ltd 1563

However, not all people agree with the efficacy of

depreciation. In March 2015, Ke-Jiang Li, the premier of

the State Council of China, commented on the trend of

Renminbi (RMB). It was mentioned that depreciation in

RMB is not welcomed, as China cannot spur exports with

depreciation while ignoring the domestic demand and

internal structure (Liu, 2015). Albeit the RMB still depre-

ciated after his talk. In June 2015, Fai-Nan Perng, the

Governor of the Central Bank of Taiwan, responded to

the public call to “permit depreciation to save the econ-

omy.”It was emphasized that if depreciation only had an

effect on exports, then indeed it would be the elixir that

everyone seeks (Wang & Chen, 2015). Moreover, in 2010,

Guido Mantega, the Brazilian then finance minister,

commented on the Real. He claimed that quantitative

easing by the Federal Reserve pushed down the US dollar

that resulted in the relative appreciation of other curren-

cies; which undoubtedly is a currency war of “beggar-

thy-neighbour”(Economist, 2015). For the two contro-

versial opposing extremes, the proposition involved not

only affects the performance of an economy, but also the

rights and interests of innocent citizens. We, of course,

can let both parties debate freely as in the Japanese

movie, “Rashoman.”However, maybe what this world

actually needs is comprehensive and reliable scientific

evidence.

Can depreciation save the economy? The related litera-

ture could roughly be categorized into three strands. The

first focuses on the exchange rate regime. For this strand,

some support the effect of a fixed regime as it can help to

reduce transaction costs and investment risk (De Grauwe&

Schnabl, 2004; Domac, Peters, & Yuzefovich, 2001;

Gylfason, 2000). Some question its efficacy as it would

restrict the market mechanism and dismantle the buffer to

external impacts(Fischer, 2001; Hung & Young, 2006). The

second providesex ante normative inference on the effectof

the exchange rate. For this strand, the world is dichoto-

mized into closed and open economies. The effect of the

exchange rateon growth is generally expectedto be present

for the small open economy with a fixed regime, and for a

large open economy, but inexistent for a small open econ-

omy with a floating regime. Meanwhile, the effect is trivial

for a closed economy. The third conducts an empirical

examinationof the proposition econometrically. Some stud-

ies have supported the effect (Abida, 2011; Ahmad,

Ahmad, & Ali, 2013;Elbadawi & Kaltani, 2011; Hausmann,

Pritchett, & Rodrik, 2005; Papanikos, 2015; Rodrik, 2008),

some rejected it (Fung, 2008; Tang, 2014), and some point

to the stability of the exchange rate (Aghion, Bacchetta,

Rancière, & Rogoff, 2009; Janus & Riera-Crichton, 2015;

Schnabl, 2008; Tharakan, 1999; Vieira, Holland,da Silva, &

Bottecchia, 2013). Moreover, some have found the

exchange rate to be a response to the economic situation,

not only the cause(Doan & Gente, 2013; Kia, 2013; Schnatz,

Vijselaar, & Osbat, 2004). Meanwhile, some studies have

identified heterogeneity in the effect for different develop-

mental stages (Gluzmann, Levy-Yeyati, & Sturzenegger,

2012; Rodrik,2008).

Despite there being no lack of literature, the issue still

needs further exploration. First, the characteristics of econ-

omies across the world are diverse. Some have huge

domestic demand and high externalities to others, for

example, the US and China, while some face a smaller

scale of internal demand and rely heavily on foreign mar-

kets and so are vulnerable to external impacts, for exam-

ple, Taiwan and the Republic of Korea. Accordingly, to

explore the output effect of the exchange rate, the impacts

of openness and scale for different regimes are crucial. Sec-

ond, the counter argument in past studies is mainly on the

grounds that the efficacy of depreciation is transient while

threatening long-run productivity. Such a view might

deserve an empirical re-examination. The reason is that

for a developing small-scaled open economy, its foreign

trade oriented industry has insufficient room to deal with

the price disadvantage resulting from relativeappreciation.

It relates to a slow action that cannot save a critical situa-

tion by just waiting for structural adjustment and insisting

on never permitting depreciation; the industry would have

lost its market share and opportunity in the global arena,

or even shrunk or died prematurely. Hence, the develop-

mental status for an economy should be considered in

exploring the output effect of depreciation. Meanwhile, it

is also of interest if the performance can be distinguished

as income growth and productivity change. Third, is the

exchange rate the cause of or response to economic perfor-

mance after all? Furthermore, are the implications of the

two kinds of performance the same?

Corresponding to the above, the novelty of this paper

is threefold. First, for the experimental design, the study

decomposes the impact of the exchange rate on the econ-

omy into common effect and individual effect under the

regression specification. It is helpful to identify the mag-

nitudes and directions of the impact on different econo-

mies with heterogeneous attributes, including openness,

scale, floatability, and development level. Second, for eco-

nomic performance, besides the explicit output growth,

the implicit total factor productivity change estimated

with generalized Malmquist index suggested by

Orea (2002) is also adopted, comprising efficiency, tech-

nology and scale dimensions. Third, for confirming the

causal direction, the causality specification proposed by

Granger (1969) and Engle and Granger (1987) is further

conducted in the empirical framework to re-examine the

nexus with time aspect.

The structure of this paper is organized as follows.

After this introduction, Section 2 reviews and comments

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