peripheral countries of the Eurozone (see, for example, Lane and Pels 2012). The inflow of capital boosted domestic demand. The increase in demand in turn pushed the prices of non-tradables while also leading to an increase of imports. Exports were largely unaffected by the shock in domestic demand because they respond primarily to foreign demand and exogenous international prices. Put simply, rising unit labor costs were not a cause but a symptom of the demand shock triggered by the inflow of capital and they were not associated with losses in exporters' competitiveness (see Gaulier and Vicard 2012).

# **4.3. Correlations with the real effective exchange rate**

The real effective exchange rate (REER) measures the development of the real value of a country’s currency against the basket of the trading partners of the country. This measure is widely used to assess changes in price and cost competitiveness. Therefore a pass test for our measure of supply-side performance is to assess the correlation with the REER.

We do so by estimating IV regressions. The baseline estimation is reported in Equation 13, where _fi,t_ is the quarterly coefficient of supply side performance. The explanatory variable is the quarterly growth rate of REER as computed by Darvas (2012) at the Bruegel Research Centre<sup>20</sup> . The database complied by Darvas covers 153 countries worldwide<sup>21</sup> , providing monthly measures of CPI-based REERs. The REERs are based on the bilateral exchange rates with 138 partners for each country, covering about 97.8% of world trade. The computations include time and country specific fixed effects.

## **Equation 11**

Table 6 reports estimates for the competitiveness measure in quantities. In both regressions we test the robustness of our results using the Nominal Effective Exchange Rate (NEER)<sup>22</sup> instead of real one; correlation remains significant and stable, both in sign and magnitude. In Table 6 column (1)(4) the significance of correlation is estimated via IV using 6 months lag of the growth rate of REER (NEER) as instruments for contemporaneous values.

Results show statistically robust negative correlations between the EERs (both in Real and Nominal terms) and the competitive measure in quantities. This indicates that decreases in the effective exchange rates of a country are associated with increases in competitiveness. This effect however takes about 6 months to materialize and gets smaller over time (further lags, not reported here, are no longer statistically significant). Coefficient for Low/Middle income countries appears to be not statically different from those of High Income countries. This may be due to poor data quality, especially approaching the end of the time period considered, resulting in a downward bias of correlation coefficients.

The correlation between the REER (NEER) and the price component of the competitiveness is of positive sign. An increase in the effective exchange rate of a country is correlated with an increase in relative export prices. At this stage, we avoid interpreting this result as an evidence of PassThrough due to two main caveats. First of all, we are dealing with a panel of heterogeneous

> 20 The quarterly growth rate is constructed on a year-on-year basis to be consistent with the dependent variables. 21 Given the high heterogeneity among reporters and data quality concerns estimation sample encompasses the first 54 countries in terms of volume of trade in year 2012, covering up to 92% of world trade.

> 22 NEER measures are also provided by Darvas (2012) at the Bruegel Research Centre.

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