The euro exchange rate and Germany's trade surplus

• Published date: 01 March 2020
• DOI: http://doi.org/10.1111/infi.12359
• Author: Marco Ratto,Stefan Hohberger,Lukas Vogel
• Date: 01 March 2020

International Finance. 2020;23:85–103. wileyonlinelibrary.com/journal/infi © 2019 John Wiley & Sons Ltd

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DOI: 10.1111/infi.12359

ORIGINAL ARTICLE

The euro exchange rate and Germany’s trade

surplus

Stefan Hohberger

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Marco Ratto

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Lukas Vogel

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1

European Commission, Joint Research

Centre (JRC), Ispra, Italy

2

European Commission, DG ECFIN,

Brussels, Belgium

Correspondence

Lukas Vogel, European Commission, DG

ECFIN, CHAR 14/233, B-1049, Brussels,

Belgium.

Email: lukas.vogel@ec.europa.eu

Abstract

In the context of debates about the euro exchange rate’s

(EXR) impact on Germany’s (DE) trade surplus, we

estimate a multiregion macroeconomic model (1999–2018)

and provide a counterfactual in which we simulate the

shocks of the estimated model in an alternative setting with

freely floating nominal EXRs. The results suggest a

reduction of the DE trade surplus by up to 1.3% of gross

domestic product (GDP; around 1/4 of the surplus) during

2010–2015 compared to the data, together with a stronger

real effective EXR (REER). The rest of the euro area (REA)

net exports are more negative (by up to −0.6% of GDP) in

the counterfactual before the EA crisis, but more positive

(by up to 0.4% of GDP) in recent years. Overall, the

counterfactual DE and REA trade balance and REER

trajectories are very similar to the actual paths. Modifying

shock processes in the counterfactual would give rise to

larger differences.

KEYWORDS

euro, exchange rate, Germany, trade balance

JEL CLASSIFICATION

E44; E52; E53; F41

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INTRODUCTION

The causes and consequences of Germany’s persistent trade surplus have been a recurrent topic

in European and international macroeconomics in recent history. While attention centred on

the implications of Germany's surplus for imbalances inside the euro area (EA) for many years,

the policy focus has shifted to spillover on non‐EA economies and global implications more

recently. Peter Navarro, for example, argued that German net exports benefit from an

undervalued euro (Financial Times, January 31, 2017). Linking the trade surplus to euro

membership, the view suggests that German net exports might have been lower without the

euro in recent years.

The “undervaluation”hypothesis has triggered lively debates among economists, with

different views on what the (conjectured) euro weakness meant for German net exports, the EA,

and the rest of the world compared to a hypothetical D‐Mark survival. Münchau (2017) argues

that the critics have a point and that Germany has manipulated its real exchange rate (EXR) by

low wage growth and support for policies that have led to a weaker euro. Fuest (2017) objects

that euro membership should not matter much for the net trade of non‐EA economies. He

argues that euro undervaluation for Germany comes with overvaluation for other EA countries,

which implies countervailing effects on EA aggregate exports to and imports from non‐EA

economies. Zettelmeyer (2017) makes the complementary point that Germany’s persistent trade

surplus is not a structural feature of Economic and Monetary Union (EMU) membership. Real

EXR adjustment in response to shocks and crisis takes longer than in a system of freely floating

nominal EXRs, but it remains possible also with EMU membership. The latter applies at least to

real effective appreciation, whereas depreciation may be complicated by downward nominal

wage rigidity in a low‐inflation environment, as argued by Krugman (2017).

This paper contributes to the discussion by presenting a simple counterfactual based on an

estimated open‐economy Dynamic Stochastic General Equilibrium (DSGE) model. Counterfactual

analysis is a major strength of DSGE models, as discussed, for example, in Coenen, Motto,

Rostagno, Schmidt, and Smets (2017). This class of models provides a framework to study the

impact on shock transmission of selective modifications to equations or parameters that

characterize macroeconomic policy, while keeping the policy‐invariant description of household

and firm behaviour unchanged. In this paper, we estimate a version of the European Commission’s

Global Multi‐country model (GM) with Germany (DE), the rest of the EA (REA), and the rest of the

world (RoW) over the period 1999q1–2018q4. GM is a structural dynamic macroeconomic (DSGE)

model and is described in detail in Albonico et al. (2019). The model builds on Kollmann et al.

(2016) and is similar to the one in Kollmann, Ratto, Roeger, in’t Veld, and Vogel (2015), who review

competing hypotheses about the drivers of the DE surplus and assess their quantitative importance.

The model includes a large number of variables and shocks and observables for estimation to

exploit a large amount of time‐series information. The analysis requires a three‐region set‐up to

account for the fact that DE is a large economy in the EA context, and distinguish between the

intra‐EA fixed nominal EXR and the floating nominal EXR toward the RoW, with REA and RoW

both being important trading partners for the DE economy.

Estimation of the DSGE model provides values for the model parameters and time profiles for

the shock processes. The counterfactual then reruns the model with the estimated shocks and an

alternative monetary policy setting that imposes a flexible nominal EXR between DE and REA and

policy rules in which the short‐term interest rate in DE responds to DE output and inflation gaps

and the short‐term interest rate in REA responds to REA output and inflation gaps only. The idea of

the counterfactual is similar to Christiano, Motto, and Rostagno (2008) and Sahuc and Smets (2008),

who compare the EA and U.S. economies and assess the role of differences in shocks and structure

for macroeconomic outcomes and the stance of monetary policy.

The simulations suggest that DE’s trade balance (TB) surplus would have been lower by up

to 1.3% of gross domestic product (GDP; around 1/4 of the actual surplus) in 2010–2015,

together with a stronger real effective exchange rate (REER), if DE had had a flexible nominal

EXR instead of being part of the EA. REA TB would have been slightly more negative under a

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