Some delayed reflections on exchange rates, trade prices, and the messages from the August data.
This post is prompted by one reader’s query whether the import price release was bullish or bearish. I still don’t have an answer to that question, but it does strike me that this is a good time to re-evaluate what is going on with import and export prices, and what that implies.
First, the oft-noted relation between import prices and the broad trade weighted exchange rate (in logs, normalized to 0 in 2002M02). Notice that total import prices have risen faster than the dollar exchange rate. However, to some extent this is not the relevant comparison since total import prices are substantially affected by petroleum and petroleum product prices, which have a substantial exogenous (with respect to the exchange rate) component. (Of course, as Brad Setser has recently pointed out, it’s not totally exogenous — when the dollar weakens, the dollar price of oil will tend to rise, to the extent that the relative price of oil is the fundamental equilibrium price.)
Figure 1: Log nominal dollar exchange rate (blue), goods import prices (red), non-oil goods import prices (green), normalized to zero in 2002M02. NBER Recession Dates shaded gray. Source: Federal Reserve Board via FREDII, BLS, and author’s calculations.
Notice that import prices have risen by about 11.2% relative to the 2002M02 value, while the dollar has fallen by about 22.6%, suggesting — if everything else were held constant — exchange rate pass through of about one half. However, not all else is held constant (this is why people do econometrics — see the estimates in the 0.25 range cited in this post).
One observation is that prices overall are jointly determined with the exchange rate, so import prices and exchange rates are responding to monetary policy and other shocks. So rising import prices might be inflationary to the extent that those movements reflect exogenous exchange rate changes.
A second observation is that to the extent that trade prices reflect the impact of exogenous exchange rate changes, there is no reason to look at only import prices. Rising export prices — to the extent that exportables are somewhat substitutable for goods in the home consumer bundle — can also introduce inflationary pressures.
Figure 2: Log nominal dollar exchange rate (blue), goods export prices (red), non-agricultural goods export prices (green), normalized to zero in 2002M02. NBER Recession Dates shaded gray. Source: Federal Reserve Board via FREDII, BLS, and author’s calculations.
Figure 2 indicates a 15.7% ex-agricultural commodities export price increase, so that a naive reading of exchange rate pass through is on the order of 69%.
A third observation (not new, see WSJ Real Time Economics) is that prices of US imports from China have finally started moving up. The fact that the Chinese yuan’s value rose for almost two years before import prices began to rise highlights several points.
Figure 3: Log nominal USD/CNY exchange rate (blue), and prices of US imports from China (red), normalized to zero in 2005M06. Source: Federal Reserve Board via FREDII, BLS, and author’s calculations.
First, sometimes it is important to consider the cost of production (that is, the price of imports is a function of both the exchange rate and the cost of production, determined in part by labor productivity). Second, to the extent that imports of intermediate goods into China are likely to have been invoiced in dollars, the impact of USD/CNY movements on prices of Chinese exports to the US is likely to have been fairly muted (the issue of vertical specialization and the impact of dollar depreciation is covered here: , ). In other words, it’s unclear exactly how much of the rise in import prices from China is due to exchange rate movements and how much is due to rising Chinese inflation.
The last observation is that rising tradables prices might not be indicative of inflationary pressures. Rather, if overall monetary policy is non-accomodative, these price changes might be just a reflection of rising overall price levels, or alternatively a relative price change (this is the expenditure switching mechanism I’ve mentioned here). I plotted the non-oil import and non-ag export price indices relative to the non-energy non-food CPI.
Figure 4: Log non-oil goods import prices to core CPI ratio (blue), and non-agricultural goods export prices to core CPI ratio (red), normalized to zero in 2002M02. NBER Recession Dates shaded gray. Source: Federal Reserve Board via FREDII, BLS, and author’s calculations.
The graph illustrates the fact the relative price of traded goods fell substantially in the lead up to the dollar peak in February 2002. The surprising finding is that while relative export prices have risen (although nowhere near where they were before), relative (non-oil) import prices have barely budged. Given this fact, the improvement in the non-oil trade balance is somewhat surprising only if one does not take into account the slowdown in US economic activity. This pattern of relative prices suggests to me that the improvement in the trade balance that has occurred thus far owes little to import reduction due to higher import prices.