On the efficacy of internal devaluations: questions I would ask Zsolt Darvas in a seminar
This post was written by Kevin O’Rourke
I notice that Philip’s last post has attracted very few comments, which is a shame, since the paper he linked to is a very important contribution to the debate, both here and in Europe, and deserves to be read widely. It is especially useful for people overseas seeking to draw lessons from the Irish experience, since it highlights the extent to which the Irish “good news story” is in fact a story about pharmaceuticals. Hence I hope Philip will forgive me if I make these comments “on the front page”, as it were.
Among the key findings are:
1. Wages declined only very slightly after the onset of the crisis here, and have since recovered. More generally, the European evidence is that wages are sticky downward.
2. The decline in unit labour costs in Ireland has been very modest once you take compositional effects into account (Figure 3, middle panel): they have been rising since 2010 and are now less than five percent lower than at the start of 2008. Indeed, for the economy as a whole they are back where they started (the previous statement was based on excluding agriculture, construction, real estate and the public service).
3. Despite 2, there has been a 14 percent depreciation of the Irish real exchange rate even taking compositional effects into account (once again, the index excludes agriculture, construction, real estate and the public service; including these the real depreciation is about half as big — Figure 3, right hand panel).
4. The Irish real exchange rate has been appreciating since 2010.
5. Peripheral adjustment has involved massive employment losses.
Here are some questions I have:
1. What happens when you calculate a composition-adjusted real exchange rate index for Ireland vis à vis other eurozone members only?
2. What happens if you include agriculture in the index? This is an important traded sector in the Irish context.
3. What happens if you do both 1 and 2?
4. One of the most striking graphs in the paper is Figure 2 on p. 6, which shows that while while manufacturing value added has risen by 30 percent since the start of 2008 (thanks to what happened in the pharmaceutical sector), gross production has only risen by 5 percent. Can we make further progress in understanding this discrepancy (there are some helpful suggestions in the paper), and what might this tell us about the movement in Irish unit labour costs and real exchange rates since the crisis began?
Update: Zsolt has kindly responded to my questions here.