Global value chains and external adjustment: Do exchange rates still matter?

• Published in: Economic modelling 2023-01, Vol.118, p.106073, Article 106073
• Main Authors: Adler, Gustavo, Meleshchuk, Sergii, Buitron, Carolina Osorio
• Format: Article
• Language: English
• Subjects: Elasticities; Exchange rates; External adjustment; Global value chains
• ISSN: 0264-9993; 1873-6122
• DOI: 10.1016/j.econmod.2022.106073

The exchange rate has traditionally been regarded as a key mechanism of external adjustment because its movement induces changes in exports and imports by affecting the price of tradable goods relative to domestic goods. However, the relevance of this mechanism has been questioned with the rise of global value chains (GVCs), because exporters increasingly use imported inputs, which implies that exchange rates affect both the price and production costs of exports. This paper studies how a country's trade balance responds to exchange rate changes in the presence of GVCs. It uses bilateral trade data for 37 economies over 2000–14, exploiting information in global input-output tables to measure countries' integration into GVCs. The results indicate that GVC integration dampens the exchange rate elasticity of export and import volumes but also leads to larger trade flows in proportion to output. Overall, the findings suggest that exchange rates remain relevant for external adjustment. •With global value chains, the impact of exchange rates on trade flows is different.•Global value chains dampen the exchange rate elasticity of trade flows.•Both, short and medium-term elasticities are lower with global value chains.•But global value chains lead to greater trade flows in proportion to GDP.•Exchange rates remain a key mechanism for external macroeconomic rebalancing.