Corker, Robert, “External Adjustment and the Strong Yen: Recent Japanese Experience”, IMF Staff Papers. Volume 36, No. 2, pages 464–493, (June 1989).
Goldstein, Maurice and Mohsin Khan, “Income and Price effects in Foreign Trade”, in Handbook of International Economics, Volume 2, edited by Ronald Jones and Peter Kenen, North Holland, Amsterdam, pp. 1041–1105, (1985).
“Japan—Background Papers”, Chapter VIII, “Exchange Rate Movements: The Role of Openness, Trade Responsiveness, and Pass-Through”, SM/95/163, Supplement 1, July 1995.
This chapter was prepared by Bankim Chadha.
Long-term movements in the yen and the role of sectoral productivity differentials in generating these movements are discussed in Chapter I, and the pass-through of exchange rate changes to export prices in Chapter VIII, of last year’s background papers (SM/95/163, Supplement 1).
In cases where the estimates implied perverse short-run dynamics, these terms were dropped. These cases—where terms have been dropped—are self-evident in Table 1. In almost all these cases, the coefficients were also statistically insignificant.
See Meredith (1993) and Chapter VIII in last year’s background papers (SM/95/163, Supplement 1) for comparisons of Japan’s trade elasticities with other studies and countries.
Since world trade has grown faster than incomes, use of the world nonoil imports series has the advantage of incorporating the upward trend in world trade into the activity series itself rather than ascribing it to a higher elasticity.
The composition of Japan’s imports has changed over the years. Particularly notable has been the steady increase in the share of manufactures, which has risen from 23 percent in 1980 to 60 percent in 1995.
Deflators for services flows are not available, making construction of volume and relative price series difficult. In the event, nominal flows were deflated by broad indices of domestic or foreign prices. For transportation flows, use of various alternative price series to deflate the nominal flows produced unsatisfactory results, and the equation was estimated in nominal terms.
Each equation in Chart 3 is forecast separately. This implies that predictions of trade volumes, for example, are based on actual export and import prices, as opposed to the fitted values from the price equations. The shocks or prediction errors, therefore, represent disturbances only to that specific equation.
In interpreting the charts, note that all scales are logarithmic, but the span for each component varies. For example, the scale for the import volume of manufactures equation spans a much larger range of movements than the panel for the raw materials equation.
Since relative export and import price changes reflect changes in either the exchange rate, domestic prices, or foreign prices, there are a variety of ways in which the model could be used to examine the effects of relative price changes. Examining alternative paths of the nominal exchange rate allows changes in Japanese export and import prices to be determined endogenously.
It is worth emphasizing the partial equilibrium nature of the model and, therefore, the caution with which these counterfactual simulations should be interpreted. If the nominal value of the yen had indeed remained unchanged during 1981-95, the economic environment, that is growth and inflation, both at home and abroad would have been different.
In practice, since the real sector forecast also depends on the external forecast, iterations are carried out to make the two consistent.
This also implies, of course, that relative import prices rise over the forecast horizon, as compared to the baseline forecast in which they are flat.