Friday, 13 June 2014

Hungary and the importance of an independent currency

Speaking of Hungarian exchange rate policy, Deborah Mabbett and Waltraud Schelkle discuss it in the course of a provocative recent argument that the lack of exchange rate autonomy is not the reason the Eurozone periphery has suffered so much in the course of the crisis. This is a really important paper, since it raises the issue of what the counterfactual implied by the case for currency autonomy is--if the Eurozone peripheral countries had their own currencies, what sort of practical situation would they be in? Formal exchange rate autonomy isn't much help if you're not willing nor able to use it.  Looking at EU countries not in the Eurozone, they write:
we found little support for the proposition that a flexible exchange rate is a useful policy instrument. ...the existence of an exchange rate makes surprisingly little difference to the extent of real devaluation. This is not to say that it is easy or even preferable to achieve real devaluation by other means (basically, internal contraction) but it is hard to sustain the argument that only nominal devaluations succeed. Furthermore, advocates of nominal devaluation may underestimate the real costs imposed on actors in the domestic economy: a particularly salient issue in Hungary and Latvia, where many households and firms had taken out foreign currency-denominated loans.
I think this is too strong, at least for Hungary--I think the evidence is that nominal devaluation has been a significant advantage, even despite the foreign loans issue, and the differences in internal contraction are quite significant.  At the chart below suggests, Hungary has seen much, much less employment loss in the course of the crisis than Greece or Spain. At the end of 2012, all three countries had seen nearly equivalent changes in real exchange rate, but Hungary's was almost entirely down to nominal exchange rate changes while those in Greece and Spain were purchased at the cost of huge increases in unemployment.  Even recently, as Hungarian real exchange rates are moving up (hopefully because workers are getting paid more as employment recovers), the nominal exchange rate has played a significant buffering role. Obviously, there are other forces in play, etc., but I still think this is pretty convincing on the backdrop of clear theoretical reasons why we expect real devaluations to be costly.
These are unit-labour-cost real exchange rates versus the Eurozone, if you care--it's not much different if you use the whole world. Sources: real exchange rates, employment
Update: the graph redrawn to emphasise employment changes - see comment


  1. Hi David,
    Thanks for your comment on our paper. But taking your graph at face value, one would have to conclude that actually real appreciation, not nominal devaluation, is good for employment. That is, a higher inflation rate stimulates domestic demand and employment. That's entirely possible but does not contradict our point about the fact that nominal devaluation is not key for adjustment (and real devaluation which all these countries arguably needed).

  2. Hi Waltraud--I agree with what you say about 2012-2013. And I agree that all these countries did see relative price adjustment. In fact, if you pick quarter 2 of 2012, they'd all had virtually identical changes in the real exchange rate since 2008Q1 - but all of Hungary's came from changes in the nominal exchange rate rather than sinking domestic labour costs. And at this point, before the bulk of Hungary's real appreciation, Hungary had paid much less of an employment price. (I've redrawn the chart above to show changes in employment to emphasise this point.) Given this, I think that exchange rate flexibility was a useful policy instrument for Hungary. In table form:
    2012Q2 RER Change in employment
    Greece 88.2 -10.4%
    Spain 89.5 -9.4%
    Hungary 90.0 -0.5%
    (Hungary's RER if there had been no devaluation would have been 102.1)