In Belgium and Firmly Ensconced in Economics
After four weeks, I confidently write that I really enjoy working at Bruegel. The think tank is in several ways a remarkable place to be. For one, it’s a diverse place. The research assistants hail from Italy and Germany, Mongolia and Sweden, Portugal and Austria. And it’s also a surprisingly small and tight-knit place. For a think tank with an outsized global reputation and impact, I expected a large operation. In fact, Bruegel’s office takes up essentially one floor of an inconspicuous building in a central part of Brussels. The entire staff present on a normal day eats lunch together at one table, occasionally at two. Of course, there are constant reminders of Bruegel’s importance. The annual meetings, our biggest event of the year, looms. Its speakers include the ministers of finance of Belgium and Slovakia, the CEO of Banco Santander, and of course, the chair of Bruegel’s board, the former president of the European Central Bank.

I’ve worked on two projects so far. The first was for Senior Fellow Francesco Papadia. He’s writing a report for the European Parliament assessing the efficiency, transparency, and cost-effectiveness of the European System of Central Banks (Eurosystem). To help him, I collected data from central bank annual reports on staff sizes and annual expenditures. It quickly became apparent that the Eurosystem employs considerably more people than the Federal Reserve System, though both serve approximately the same number of people. To see if this difference were driven by individual, overstaffed national central banks, I regressed those staff sizes on relevant macro variables like population, GDP, and bank balance sheets. I found strong correlations, suggesting that system wide features of the Eurosystem drive the variance in staff sizes. I also wrote a small report for Papadia describing some salient differences between the Fed and the Eurosystem. Unfortunately, for the sake of simple comparison, the central banks are significantly different from how they transmit monetary policy to how they regulate bank and non-bank financial entities.
I am also working on creating a report for Guntram Wolff, Bruegel’s director, on how nominal exchange rate fluctuations affect the balance of trade. Intuitive, classical economic theory will tell you that a real depreciation should increase exports (they are less expensive in foreign currencies) and decrease imports (they are more expensive in domestic currency). This link seems so obvious it is rarely, if ever, explored in introductory, intermediate, or even advanced economics classes. In fact, the link is not obvious.

Today, firms compete by producing value-added, not necessarily by producing final goods. Exporters are often themselves importers. They import intermediate goods, add value, and then export them, sometimes as final goods and sometimes as intermediate goods for additional processing in a second market and sale in a third market. This suggests that depreciations may meaningfully increase marginal costs for exporters, making their products more expensive in foreign markets and countervailing the negative pressure on foreign currency price by the depreciated exchange rate. Moreover, exchange rate pass-through to imports is sometimes quite low, especially in advanced economies. Exchange rate fluctuations sometimes do not appear in import prices because firms engage in local currency pricing and pricing to market behavior. Exporters sometimes set their prices not in their domestic currency, but in foreign currency, thereby absorbing exchange rate fluctuations in their bottom line. When exporters to a country engage in this behavior, the price of imports for that country is sometimes unresponsive, or inelastic, to exchange rate fluctuations. I’ve been examining the literature on this topic and building some time series to visualize trends in certain countries of interest. Particularly interesting is how in recent years, real deprecations in the UK, even very large ones (over 30 percent) have had no clear effect on the trade balance. The challenge here of course, is remembering that exchange rates are endogenous to many macroeconomic variables, so a simple time series analysis can be misleading. Nonetheless, massive real depreciations leaving the trade balance unaffected is at least suggestive of something unusual. And if the link between a depreciating currency and an improved current account balance is indeed unclear or nonexistent in the UK, this would have significant policy implications. Many in the UK who favored Brexit did so on the grounds that a depreciating currency would bring significant benefits to the economy by facilitating external rebalancing. The data, however, simply may not support this.
Written by Nicholas Branigan, FSI Global Policy intern through The Europe Center with Bruegel in Brussels, Belgium.
