The author would like to thank Steven Dunaway and Yusuke Horiguchi, in particular, and other staff colleagues as well for helpful comments.
For example, nonagricultural export prices and non-oil import prices are substantially overpredicted since 1985 in William Helkie and Peter Hooper, “An Empirical Analysis of the U.S. External Deficit, 1980–86,” in Ralph Bryant, et al, eds., External Deficits and the Dollar; The Pit and the Pendulum, the Brookings Institution, 1988, and in Hooper and Catherine Mann, “The U.S. External Deficit: Its Causes and Persistence,” October 1987.
For a study of import price behavior, see also Steven Dunaway and Lloyd Kenward, “U.S. Import Prices and Dollar Depreciation” (unpublished, IMF, 1987).
It may be noted in this connection that unit labor costs in the nonfarm business sector have risen at a modest pace since early 1985.
Implicit deflators are current-weighted indices and therefore their movements reflect the effects of both shifts in commodity composition and genuine price changes. The large increase in the weight of business machines has magnified the impact of the drop in their prices on the implicit deflator for nonagricultural exports.
The index is based on 1982 weights and includes autos, capital goods, and consumer goods. Since this is an index for manufactured exports, commodities are excluded.
In both cases, the price of domestically produced business machines is used. In addition to influencing the aggregate indices, this use of domestically produced business machines has two shortcomings. First, the mix of domestic machines differs from that of imports. Second, the steep decline in the dollar since early 1985 probably implies that the price of imported machines is rising relative to those produced domestically.
As in the case of the alternative export price index, this index includes autos, capital goods, and consumer goods, and excludes commodities.
The alternative index covers seven major industrial countries, Hong Kong, Korea, Mexico, and Taiwan Province of China, and is weighted by their shares in U.S. imports of manufactured goods in 1980.
Foreign production costs are calculated as the weighted average of raw materials prices and unit labor costs in manufacturing, using input-output weights for each country.
The difference between movements in U.S. import prices and foreign exports prices in U.S. dollars also may reflect differences in commodity composition and the influence of import restrictions such as the voluntary export restraints on Japanese automobiles.
Constant returns to scale and constant demand elasticity are commonly used assumptions and allow technical progress (or productivity gains) to be subsumed in the unit labor cost variable and the export price to be independent of the level of total output.
For similar formulations of trade price behavior see Jacques Artus, “The Behavior of Export Prices for Manufactures,” The Effects of Exchange Rate Adjustments, P. Clark, et al, Ed., Department of the Treasury, 1974; Isher Ahluwalia and Ernesto Hernández-Catá, “An Econometric Model of U.S. Merchandise Imports Under Fixed and Fluctuating Exchange Rates, 1959-73, “IMF Staff Papers,” November 1975.
The necessary data was obtained from numerous national sources. Details are available upon request.
Since the equation includes a lagged endogenous variable and initial regressions indicated serially correlated errors, an instrumental variable approach was used in order to obtain a consistent estimate of the degree of first-order serial correlation (p). Tests of the residuals of the equation corrected for serial correlation did not indicate any remaining serial correlation. The equation for foreign export prices was estimated in a similar fashion.
Pass-through is defined here to measure the extent to which changes in exchange rates, foreign prices or domestic costs would be reflected in export prices. It does not include the indirect effect of exchange rate changes on prices through their impact on domestic costs, which is a separate issue.
In the absence of appropriate data on wholesale prices of intermediate goods, the overall wholesale price index was used for Mexico and Taiwan Province of China, the industrial producer price index for Canada, and the consumer price index for Hong Kong.
The lag coefficients were estimated using an Almon lag distribution of degree 2 with no end-point constraint.
It should be noted, however, that the strong presence of serial correlation suggests that the equation is probably affected by errors of measurement such as differences in commodity composition or changes in pricing to the U.S. market relative to the rest of the world.
The post-sample predictions did not incorporate the effect of serially correlated errors.