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Measuring U.S. international relative prices: a WARP view of the world

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Author Info
Charles P. Thomas
Jaime Marquez
Sean Fahle
Abstract

In this paper we construct a new measure of U.S. prices relative to those of its trading partners and use it to reexamine the behavior of U.S. net exports. Our measure differs from existing measures of the dollar's real effective exchange rate (REER) in that it explicitly incorporates both the difference in price levels between the United States and developing economies and the growing importance of these developing economies in world trade. Unlike existing REERs, our measure shows that relative U.S. prices have increased significantly over the past 15 years. In terms of simple correlations, the relationship between our measure of relative prices and U.S. net exports is much more coherent than that between existing REERs and net exports. To explore this relationship further, we use our measure to construct an index of foreign prices relevant for U.S. export volumes and reexamine several export equations. We find that export equations with the new index dominate those with previous measures in terms of in-sample fit, out-of-sample fit, and parameter constancy. In addition, we find that with the new index of foreign prices the estimated elasticity of U.S. exports with respect to foreign income is a good bit higher than the unitary elasticity found in previous studies using other price measures. This has implications for U.S. current account adjustment.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 917.

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Date of creation: 2008
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Handle: RePEc:fip:fedgif:917

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Keywords: Exports ; Foreign exchange rates ; Econometric models;

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References listed on IDEAS
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  1. Feenstra, Robert C, 1994. "New Product Varieties and the Measurement of International Prices," American Economic Review, American Economic Association, vol. 84(1), pages 157-77, March. [Downloadable!] (restricted)
  2. Dominique Desruelle & Alessandro Zanello, 1997. "A Primer on the IMF's Information Notice System," IMF Working Papers 97/71, International Monetary Fund.
  3. Anderson, Richard G & Thursby, Jerry G, 1986. "Confidence Intervals for Elasticity Estimators in Translog Models," The Review of Economics and Statistics, MIT Press, vol. 68(4), pages 647-56, November. [Downloadable!] (restricted)
  4. Michael P. Leahy, 1998. "New summary measures of the foreign exchange value of the dollar," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Oct, pages 811-818. [Downloadable!]
  5. Robert C. Feenstra & Alan Heston & Marcel P. Timmer & Haiyan Deng, 2004. "Estimating Real Production and Expenditures Across Nations: A Proposal for Improving the Penn World Tables," NBER Working Papers 10866, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Menzie D. Chinn, 2005. "A Primer on Real Effective Exchange Rates: Determinants, Overvaluation, Trade Flows and Competitive Devaluation," NBER Working Papers 11521, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. B. Dianne Pauls, 1987. "Measuring the foreign-exchange value of the dollar," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jun, pages 411-422.
  8. Mico Loretan, 2005. "Indexes of the foreign exchange value of the dollar," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Win, pages 1-8. [Downloadable!]
  9. Goldstein, Morris & Khan, Mohsin S., 1985. "Income and price effects in foreign trade," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 20, pages 1041-1105 Elsevier. [Downloadable!] (restricted)
  10. Martine Durand & Christophe Madaschi & Flavia Terribile, 1998. "Trends in OECD Countries’ International Competitiveness: The Influence of Emerging Market Economies," OECD Economics Department Working Papers 195, OECD, Economics Department. [Downloadable!]
  11. Peter Hooper & J. David Richardson, 1991. "International Economic Transactions: Issues in Measurement and Empirical Research," NBER Working Papers 3805, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Froot, Kenneth A. & Rogoff, Kenneth, 1995. "Perspectives on PPP and long-run real exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688 Elsevier. [Downloadable!] (restricted)
  13. Houthakker, Hendrik S & Magee, Stephen P, 1969. "Income and Price Elasticities in World Trade," The Review of Economics and Statistics, MIT Press, vol. 51(2), pages 111-25, May. [Downloadable!] (restricted)
  14. Peter Hooper & John Morton, 1978. "Summary measures of the dollar's foreign exchange value," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Oct, pages 783-789.
  15. Robert E. Lipsey & Linda Molinari & Irving B. Kravis, 1992. "Measures of Prices and Price Competitiveness in International Trade in Manufactured Goods," NBER Working Papers 3442, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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