One component of Abenomics is a vigorously expansionary monetary policy. The yen has depreciated substantially as a consequence — as of February, about 20% relative to 2012Q3. One question is how much of an expenditure switching effect this depreciation will induce. In order to examine this question, I have done some quick and dirty econometrics, summarized in this paper.
Figure 1: Log CPI-deflated trade weighted value of the Japanese yen, 2005=0. Source: IMF, IFS and author’s calculations.
Figure 2: Log real goods imports (blue) and goods imports ex.-fuel (red), and real GDP (green), rescaled to 1990Q1=0. Source: OECD, QNA, MoF, and author’s calculations.
Figure 3: Log real goods exports (blue) and real export-weighted rest-of-world GDP (green), rescaled to 1990Q1=0. Source: OECD, QNA, IMF, IFS, and author’s calculations.In short, my estimates suggest that non-fuel goods imports respond with about unit elasticity to real exchange rate changes, while exports respond with an elasticity of about 0.7, over the 1990-2012 sample period. The Marshall-Lerner conditions are thus satisfied (nonfuel goods imports are about 2/3 of total goods imports, so even if fuel imports have zero elasticity, the condition would still likely hold).
These estimates differ slightly from those reported by Crane et al. (2007), who worked with a sample over the 1980-2006 period. They find exports that imports are relatively insensitive to price changes, while the export price elasticity is about 0.34. More recent estimates(Thorbecke, 2012) suggest that the export elasticity is between 0.44 to 0.61.
That being said, there is considerable uncertainty surrounding the estimates, since the point estimates vary with real exchange rate measure (CPI deflated or ULC deflated), and the treatment of time trends. The estimates of import income elasticities in particular (but all elasticities in general) are particularly sensitive. Inspection of Figure 2 suggest why this is the case; during the sample period, import penetration rises considerably. That phenomenon is captured by the time trend (or trends), so differing treatments provide differing estimates of the income elasticity.
Overall, the evidence from past studies as well as these estimates suggests that a yen depreciation can aid in boosting aggregate demand. The question remains open whether impacts (for instance, higher energy prices arising from dollar denomination of fuel imports) might mitigate these positive effects.
This piece is cross-posted from Econbrowser with permission.