Exports and the Exchange Rate: A General Equilibrium Perspective
How do a country’s exports change when its currency depreciates? The typical view is that currency depreciation leads to higher exports because it lowers export prices and entices foreign buyers to switch spending toward these goods. But why the exchange rate depreciates in the first place might also matter. In this article, we shed light on this aspect of the issue.
We ask whether the relationship between exchange rate movements and exports differs depending on the fundamental driver of the exchange rate. Using data for Canada, we identify cases where the Canada-US exchange rate changes because of factors such as Canadian monetary policy, global oil prices and US income growth. From there, we account for how exports evolve in each of these cases.
We find that exports evolve very differently from one shock to another. This, we argue, reflects that the direct impact of the exchange rate on export prices and export purchases is weak. Instead, the main driver of exports for Canada is not the exchange rate but rather US growth, which sometimes comoves with the exchange rate. Our findings suggest that the exchange rate’s role as an automatic stabilizer and in transmitting monetary policy for Canada is not as strong as is traditionally assumed.