When will the dollar boost the economy?

Barclays has a an interesting note out on the likely impact of the falling dollar on GDP.

The RBA has provided the first new estimates of the impact of the exchange rate on growth in almost a decade
In the latest Statement on Monetary Policy, the Reserve Bank published its first estimate of the impact of the exchange rate on growth since it last explored the issue in a 2005 research paper.

• In 2005, the Reserve Bank presented results that showed that an 18% drop in the real exchange rate boosted growth by about 1pp, with most of the effect felt in the first year.
• Now, the Reserve Bank has said that “central estimates [from research] suggest that a 10% depreciation of the exchange rate stimulates GDP growth by ½-1 percentage point over a period of two years or so”.

Interestingly, the more recent research is similar to our own work that showed that a 9% drop in the real exchange rate boosted growth by close to 1pp.

We used the RBA estimates to calibrate the impact of the exchange rate on activity over time
To get a crude sense of the impact of the exchange rate on activity over time, we took the mid-point of the RBA’s estimates, such that a 10% drop in the exchange rate boosts growth by about 0.75pp. We then used a normal distribution to calibrate the boost to growth from a depreciation of the exchange rate over a two-year period.

By design, the results show that most of the impact of a lower exchange rate are felt at the end of the first year and early in the second year (see Figure 1). We are mindful that the Reserve Bank may have a different profile for the impact of the exchange rate, although the bank’s 2005 analysis also showed that the most of the effect was felt around the 1 year mark.

The recent drop in the exchange rate should provide a modest boost to growth, most apparent in Q2 and Q3 next year
The stylised impact of the currency on activity suggests that the recent 10% drop in the real exchange rate should start to boost growth later this year, although allowing for the residual lagged effect of earlier appreciations offsets this initial lift. As a result, the currency’s effect will probably not be apparent in GDP until early next year, with a peak boost to activity of about 0.2pp in each of Q2 and Q3 in 2014.

I agree that the RBA is right to be watering down the impacts of the falling currency. Given our circumstances of coming off a huge mining boom, the currency won’t help mining as much as it would usually, nor will it help broader tradables as quickly owing to hollowing out.

Having said that, the lower it gets the better and the Barclays forecasts don’t look unreasonable. Their growth forecast is also worth a look:

2014 GDP of 2.3% with net exports accounting for 2.1% of that. That’s real activity for everything else of 0.2 for the year. That’ll be fun.