Identifying Determinants of Germany's International Price Competitiveness

The paper employs a structural vector auto-regression (SVAR) along the lines of Blanchard and Quah (1989)and Clarida and Gali (1994) to identify the sources of changes in German international price competitivenessover the past 30 years. This leads to a separation of the driving forces of the real exchange rate into real demand,supply, and nominal shocks. Based on this decomposition, it is analysed whether real exchange rate changeshave helped to stabilise output in the post re-unification period and whether such changes have facilitated theongoing structural adjustment process of the German economy. The results indicate that real demand andnominal shocks have been the main drivers of the real exchange rate in the past, whereas output fluctuationshave been almost entirely due to supply shocks. In particular, it turns out that improvements of Germany’s pricecompetitiveness in the second half of the 1990s have been primarily the result of a relative domestic demandrestraint and hardly that of supply side expansions.