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Measurement Matters: Productivity-Adjusted Weighted Average Relative Price Indices

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  • Douglas L. Campbell

    () (New Economic School (NES))

Abstract

Commonly used trade-weighted real exchange rate indices are computed as indices-of-indices, and thus do not adequately account for growth in trade with developing countries. Weighted Average Relative Price (WARP) indices solve this problem but do not control for productivity differences, as developing countries are observed to have lower price levels via the Penn Effect. I remedy these problems in two ways. First I propose a Penn Effect productivity adjustment to Weighted Average Relative Price indices (P-WARP). Secondly, I introduce a Weighted Average Relative Unit Labor Cost index (WARULC) for manufacturing and show that this measure does a much better job predicting trade imbalances and declines in manufacturing employment than the IMF’s Relative ULC measure created as an index-of-indices. The new series reveal that for many countries currently mired in liquidity traps, relative prices reached historic highs heading into the financial crisis of 2008. I document that in 2002 – during the surprisingly sudden collapse in US manufacturing – US relative prices had not been that high relative to trading partners since the worst year of the Great Depression.

Suggested Citation

  • Douglas L. Campbell, 2015. "Measurement Matters: Productivity-Adjusted Weighted Average Relative Price Indices," Working Papers w0216, Center for Economic and Financial Research (CEFIR).
  • Handle: RePEc:cfr:cefirw:w0216
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    References listed on IDEAS

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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Robert Lawrence's New Manufacturing Paper: Confusing Trends and Levels
      by Doug Campbell in Douglas L. Campbell on 2017-11-16 16:13:00

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    1. Douglas L. Campbell & Lester Lusher, 2016. "The Impact of Real Exchange Rate Shocks on Manufacturing Workers: An Autopsy from the MORG," Working Papers w0223, Center for Economic and Financial Research (CEFIR).

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    Keywords

    Real Exchange Rate Indices; Relative Unit Labor Cost Indices; Weighted Average Relative Prices; Balassa-Samuelson; Trading Partner Substitution Bias;

    JEL classification:

    • F10 - International Economics - - Trade - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • N70 - Economic History - - Economic History: Transport, International and Domestic Trade, Energy, and Other Services - - - General, International, or Comparative
    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation

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