Export Growth Dynamics and Real Exchange Rate: Evidence from Armenia

Abstract

In the light of recently revealed evidence that suggests a weaker impact of exchange rates on trade, this paper empirically studies the link between real exchange rate and exports in the context of a developing country, Armenia, using quarterly data from January 2001 to June 2019. In the course of this analysis, by performing a rolling regression, we confirm the evidence of a subdued impact of exchange rates on exports. We also investigate the effects of exchange rate volatility on exports for Armenia, where exchange rate risk is not generally hedged by exporting firms. Though dozens of studies have examined the effect of exchange rate fluctuations on international trade, the influence of exchange rate volatility is still ambiguous from empirical point of view. Our estimations indicate that short-term exchange rate volatility has no impact on exports. Finally, we study the dynamics of the prolonged overvaluation of exchange rates observed in the economy of Armenia since the early 2000s, which caused a continual deterioration in its external competitiveness. Using the instrumental variable–generalized method of moments (IV-GMM) framework, we estimate a two-stage model for the real effective exchange rate (REER) with endogenous remittances and find evidence of the Dutch disease in Armenia.

KEYWORDS:

• Dutch disease
• exchange rate volatility
• exports
• IV-GMM
• real effective exchange rate
• rolling regression

JEL CLASSIFICATIONS:

• C22
• F10
• F14
• F31
• F41

Acknowledgments

We thank the editor of International Economic Journal and the two anonymous referees for their insightful and helpful comments that helped improve the quality of the paper. Aleksandr Grigoryan acknowledges partial support fromAsianDevelopment Bank [grant number TA-9045ARM(48040-001)]. The article reflects the views of the authors and not those of the institutions with which the authors are affiliated.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

1 Large inflows of foreign currency boost demand for domestic goods. The price increase in domestic goods appreciates the real exchange rate and causes a decline in exports. The channel known as the spending effect of the Dutch disease (Corden, 1984; Corden & Neary, 1982).

2 Over the period of analysis, the main trading partners are Russia, Switzerland, Bulgaria, Germany, the Netherlands, Belgium, Georgia, Italy, and Israel.

3 Models that capture the persistence of the dependent variable are popular in macroeconomics literature. In their seminal paper, Clarida et al. (2000) estimate a model with persistence for a monetary policy Taylor rule. They discuss the policy adjustment process, analyzing persistence and contemporaneous components in detail. Engel and West (2005) estimate a similar model for the nominal exchange rate.

4 Although the literature focuses on the nominal exchange rate, the forward-looking structure equally refers to the real exchange rate, as the latter is the function of its nominal counterpart. In particular, domestic and foreign prices are determined by their future values, modeled as Philips curves in the new Keynesian dynamic stochastic general equilibrium (DSGE) models. Silveira (2006) develops a two-country new Keynesian DSGE model, in which forward-looking equations for home and foreign countries are derived in steps.

5 Gali and Gertler (1999) estimate forward-looking model by GMM for Philips curve.

6 Endogeneity of remittances is due to simultaneity problem – remittances and REER are determined jointly, resulting in reverse causality in the econometric model. Also, there can be omitted variable(s), which are correlated with both remittances and REER. The former source of endogeneity is dominant.

7 Nevertheless, formal hypothesis testing does not confirm evidence of inelastic exports in either of the models.

8 Lag order selection is a part of model identification. See, e.g. Gali and Gertler (1999) and Clarida et al. (2000).

9 The literature has reached a broad consensus that overvaluation damages both exports and economic growth (e.g. Berg et al., 2012; Johnson et al., 2017). The institutional consequences of overvaluation are a high rate of rent-seeking and corruption, unsustainably large current account deficits, and balance-of-payments crises (Rodrik, 2008). Regarding the implications for financial stability, persistent real exchange rate overvaluation is an early warning signal of a possible currency crash (Frankel & Rose, 1996; Kaminsky & Reinhart, 1999; Krugman, 1979).

10 Large inflows of foreign currency boost demand for domestic goods. The price increase in domestic goods appreciates the real exchange rate and causes a decline in exports.

Additional information

Funding

This work was supported by Asian Development Bank [grant number TA-9045 ARM (48040-001)].

Notes on contributors

Gor A. Khachatryan

Gor A. Khachatryan is a Lecturer in the Faculty of Mathematics and Mechanics at Yerevan State University and the Director of Economic Research Center at the Ministry of Economy of the Republic of Armenia.

Aleksandr Grigoryan

Aleksandr Grigoryan is an Associate Professor in Manoogian Simone College of Business and Economics at American University of Armenia and a CERGE-EI Foundation Teaching Fellow.