August 20, 2001


To What Extent Does Productivity Drive the Dollar?, the latest edition of the New York Fed’s Current Issues in Economics and Finance, is enclosed for your review.

Differences in productivity growth between the United States, Japan and the euro area account to a substantial extent for the ten-year swings of the real dollar exchange rate over the past three decades, according to Cedric Tille, Nicolas Stoffels, and Olga Gorbachev. Specifically, the robust productivity growth achieved by the United States in the 1990s explains three-quarters of the strengthening of the dollar against the yen and two-thirds of the dollar’s appreciation against the euro in that decade.

The authors draw on earlier theoretical work indicating that the impact of productivity gains on a currency’s value depends on the distribution of the gains between the economy’s traded sector (export and import-competing industries) and nontraded sector (industries producing for the domestic market and facing no competition from abroad). According to the theory, productivity growth will lead to a real exchange rate appreciation only if it is concentrated in the traded sector of an economy.

Examining sector-specific productivity patterns within the United States, Japan, and the euro area, the authors find that the "sectoral productivity gap"—productivity growth in the traded sector minus productivity growth in the nontraded sector—has increased substantially in the United States while it has remained relatively steady in the euro zone and fallen in Japan.

To determine whether these sectoral patterns can account for dollar-yen and dollar-euro exchange rate movements over a long time period, 1970-1999, the authors construct a measure of productivity growth differentials that compares the sectoral productivity gap in the United States with the corresponding gaps in Japan and the euro area. "By tracking the changes in this measure over time," the authors note, "we can identify the changes in the real exchange rate that can be directly attributed to productivity gains."

The authors find that the sectoral productivity gap can explain most of the fluctuations in the dollar-yen real exchange rate between 1970 and 1999. It also performs well—although not as consistently—in explaining movements in the dollar-euro exchange rate over the thirty-year period.

Contact: Peter Bakstansky or Steven Malin