No . 21 - 2011 Real Exchange Rate Uncertainty and Output : A Sectoral Analysis

Developing countries exhibit a more uncertain economic environment than developed countries. Argentina, Brazil and Uruguay in particular, display high levels of real exchange rate uncertainty. Moreover, a succession of trade agreements among them, culminating in the creation of Mercosur in 1991 have increased intra-regional trade. This paper examines empirically the impact of real-effective-exchange-rate (REER) uncertainty on the output of 28 manufacturing sectors in Argentina, Brazil and Uruguay over 1970-2002. It provides alternative uncertainty measures that take into account the non-normality of the REER distribution by considering its higher moments (skewness and kurtosis) and different degrees of sophistication in agents’ expectation formation, and estimates an augmented supply function using sectoral data on output, prices, and including these measures of REER uncertainty. Two different sets of instruments are used for domestic prices, in order to deal with the simultaneity problem that arises in the estimation of the supply function. Results suggest a negative non-negligible effect of uncertainty on output, homogeneous across countries. Interestingly, there is evidence of threshold effects, so that uncertainty affects output negatively when it exceeds some critical level. In addition, the effect is heterogeneous across sectors. This is explained by trade orientation, the intensity with which the sector trades within Mercosur and by sectoral productivity. Sectors that trade more intensively within Mercosur are more affected by REER uncertainty than those predominantly oriented to the rest of the world. Second, more productive sectors are less affected by REER uncertainty than those that are less productive.’ JEL Classification: E23, F15, F31