Trade Elasticities and the Depreciation of Sterling

Abstract:

Knowledge of the price and income elasticities of trade is of relevance as they provide guidance to the impact of fluctuations in sterling and foreign demand on the domestic economy. Fluctuations in demand have a stronger impact on trade volumes than exchange rate movements. Both price and income elasticities may have declined in recent years. Finally, illustrative simulations using NiGEM suggest that, depending on the magnitude of the price elasticity of exports, a 10 per cent depreciation of sterling, keeping everything else constant, induces an increase in output between 0.6 and 0.8 per cent on impact, with a peak effect between 1.2 and 1.5 per cent after a year. Caution must be observed as the results are highly sensitive to the fundamental shock driving the devaluation of Sterling.

NiGEM Observations is a series of occasional notes published by the NiGEM team on topical macroeconomic modelling issues for NIESR corporate sponsors and NiGEM subscribers.