Summary of WP/94/132: “Exchange Rate Fluctuations and U.K. Manufacturing Exports”

Authors of Working Papers are normally staff members of the Fund or consultants, although on occasion outside authors may collaborate with a staff member in writing a paper. The views expressed in the Working Papers or their summaries are, however, those of the authors and should not necessarily be interpreted as representing the views of the Fund. Copies of individual Working Papers and information on subscriptions to the annual series of Working Papers may be obtained from IMF Publication Services, International Monetary Fund, 700 19th Street, Washington, D.C. 20431. Telephone: (202) 623-7430 Telefax: (202) 623-7201 This compilation of summaries of Working Papers released during July-December 1994 is being issued as a part of the Working Paper series. It is designed to provide the reader with an overview of the research work performed by the staff during the period.

Abstract

Authors of Working Papers are normally staff members of the Fund or consultants, although on occasion outside authors may collaborate with a staff member in writing a paper. The views expressed in the Working Papers or their summaries are, however, those of the authors and should not necessarily be interpreted as representing the views of the Fund. Copies of individual Working Papers and information on subscriptions to the annual series of Working Papers may be obtained from IMF Publication Services, International Monetary Fund, 700 19th Street, Washington, D.C. 20431. Telephone: (202) 623-7430 Telefax: (202) 623-7201 This compilation of summaries of Working Papers released during July-December 1994 is being issued as a part of the Working Paper series. It is designed to provide the reader with an overview of the research work performed by the staff during the period.

The United Kingdom’s export performance since the 1970s, it has often been argued, has reflected a tendency for U.K. exporters to use favorable exchange rate movements to improve profit margins rather than to strengthen their competitive position and boost foreign demand for their products. Exports, however, also depend on supply-side performance, which, unlike demand, is positively influenced by improved profit margins. The effect of exchange rate fluctuations on export performance therefore depends on the price sensitivities of both supply and demand and on the pricing policies of exporting firms. In a competitive international market, exporting firms follow a pricing-to-market policy, taking prices in foreign currencies as given and offsetting the effects of exchange rate depreciation by appropriately adjusting local currency export prices. At the opposite extreme, setting prices based only on domestic factors, for example in order to preserve profit margins, implies a full exchange rate pass-through to consumer prices abroad. The former pricing policy maintains demand while the latter sustains the firm’s ability to invest and supply.

Depending on the market structure, a lack of response (or a partial response) of export prices to sharp or sudden exchange rate fluctuations could indicate the presence of hysteresis in the sense that a transitory shock to the system would permanently change relative prices. Moreover, when investment and production involve costs that are irreversible, the supply of exported goods may manifest hysteresis that arises from the entry and exit decisions of firms. The response of export prices to exchange rate movements may also depend on the prevailing exchange rate regime. A question in relation to the United Kingdom is whether this response was influenced by sterling’s membership in the ERM and its subsequent departure from the system in September 1992. In principle, the disciplinary effects of a credible fixed exchange rate system are likely to influence price determination by, for example, reducing the likelihood that devaluations will be used to improve competitiveness.

This paper examines the impact of exchange rate fluctuations on U.K. manufacturing exports. The results indicate a recursive structure in the long run, wherein prices influence the volume of exports demanded but are not influenced by it. They also indicate that U.K. exporters only partially offset the impact on foreign consumers of fluctuations in the effective exchange rate of the pound. During the ERM period, however, the extent of pass-through to foreign prices weakened, a process that appears to have reversed after exit from the ERM. Hysteresis in the form of limited exchange rate pass-through is supported by the results, but that arising from regime switches in supply is not.

Working Paper Summaries (WP/94/77 - WP/94/147)
Author: International Monetary Fund