Working Paper: CEPR ID: DP527
Authors: Charles Wyplosz
Abstract: It is often believed that the German Economic and Monetary Unification will result in an appreciation of the DM. This conclusion is reached when attention is exclusively directed to the short-run demand side. In this note, it is shown that supply-side and long-term considerations suggest instead that the DM will depreciate in the long term. The reason is that the absorption into the new DM-zone of an area with initially scant productive assets amounts to a permanent fall in per capita wealth of the new Germany relative to the old one. An alternative interpretation is that the real depreciation is required to compensate a worsened net asset position (as Germany borrows abroad to finance capital accumulation). While the short-run effect is ambiguous, a real depreciation is shown to be possible, and the conditions for it to happen are spelled out.
Keywords: exchange rate; external borrowing; capital accumulation
JEL Codes: 130; 430; 440
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| GEMU (C68) | depreciation of the DM (F31) |
| absorption of East Germany into the DM zone (F55) | permanent fall in per capita wealth (E21) |
| permanent fall in per capita wealth (E21) | depreciation of the DM (F31) |
| low initial capital stock in East Germany (P23) | lower productivity and wages (J39) |
| lower productivity and wages (J39) | impacts consumption and investment decisions (E20) |
| initial decline in per capita wealth (E21) | reduces average spending (D12) |
| reduces average spending (D12) | necessitates real depreciation (F31) |
| increased capital investment in the East (E22) | trade deficits (F14) |