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Through the Looking Glass: A WARPed View of Real Exchange Rate History

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  • Campbell, Douglas L
  • Pyun, Ju Hyun

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 Balassa-Samuelson effect. In this paper, we remedy these problems in two ways. First we propose a Balassa-Samuelson productivity adjustment to Weighted Average Relative Price indices (BS-WARP). Secondly, we 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. Our series reveal that for many countries currently mired in liquidity traps, relative prices reached historic highs heading into the financial crisis of 2008. We 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

  • Campbell, Douglas L & Pyun, Ju Hyun, 2014. "Through the Looking Glass: A WARPed View of Real Exchange Rate History," MPRA Paper 55870, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:55870
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    References listed on IDEAS

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    Citations

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    Cited by:

    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).
    2. Peter H. Lindert & Jeffrey G. Williamson, 2016. "American colonial incomes, 1650–1774," Economic History Review, Economic History Society, vol. 69(1), pages 54-77, February.
    3. Douglas L. Campbell & Lester Lusher, 2016. "Trade Shocks, Taxes, and Inequality," Working Papers w0220, Center for Economic and Financial Research (CEFIR).

    More about this item

    Keywords

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

    JEL classification:

    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • N7 - Economic History - - Economic History: Transport, International and Domestic Trade, Energy, and Other Services

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