Heterogeneous effects of foreign exchange appreciation on industrial output: Evidence from disaggregated manufacturing data

Abstract

Real exchange rate fluctuations impact domestic economic activity throughout the trade and financial channels. Using granular data from the Brazilian manufacturing sector, we decompose the manufacturing sector into different sub-sectors according to their net exposures to international trade and analyze how the industrial production responds to real exchange rate appreciation innovations. On the aggregate level, our evidence suggests a non-significant role of the exchange rate in explaining the dynamics of industrial production, before and after the Great Financial Crisis of 2008. However, consistent with the trade channel of real exchange rates, we find that shocks to the exchange rate (e.g., an unanticipated depreciation) positively (negatively) affect output in net export (import) sectors. Though non-homogeneous, these effects are modest in terms of economic magnitude. Further, by including analysts’ macroeconomic forecasts in the model, we find that such effects stem from exogenous, unanticipated shocks to the exchange rate. Our evidence is robust to a trade-weighted measure of the exchange rate and to alternative manufacturing outcomes rather than output. Overall, our results highlight how heterogeneous are manufacturing responses to exchange rate shocks in an important emerging economy.