Real Exchange Rate Volatility, Economic Growth and the Euro

This paper studies the effect of real effective exchange rate (REER) volatility on economic growth as well as the euro’s effect on REER volatility. We first show that, after a plausible endogeneity correction, REER volatility is negatively associated with growth in a 1980~2011 panel of OECD countries. One standard deviation volatility decrease is associated with about two percentage points (0.8 standard deviations) growth increase. Second, we find that euro adoption was associated with a decline of 0.4 standard deviations in long-run REER * volatility before the Great Recession in 2008~09. Moreover, while the Great Recession increased REER volatility by 38-189 percent of the sample mean outside the euro-zone, the REERs of euro adopters were almost completely insulated. We conclude that REER stability may be growth-enhancing in OECD countries and the euro may therefore have played a growth-enhancing role at least before the recent euro-zone debt crisis. JEL: F31, F32, F33