Do exchange rate movements still impact the current account balances in the Age of Global Value Chains (GVCs)? Exchange rate depreciation makes foreign inputs more expensive, expanding the costs of import, while it only increases the competitiveness of domestic inputs embodied in a country’s gross export. Since all countries supply inputs to other countries while also importing them for further processing, greater integration into GVCs should thus mute the competitiveness gains of depreciation. To provide empirical evidence, we rely on a large panel of 60 countries over the 1995-2018 periods and find evidence of diminishing elasticity of exchange rates on trade. In other words, higher GVC participation makes trade insensitive to exchange rate movements. Accordingly, diminishing elasticity of exchange rates on trade decreases the impact of monetary policy shock on the exchange rates and hinders external rebalancing. Depreciation is not thus a one-size-fits-all tool to reduce current account deficits in the Age of GVCs.

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