Friday, October 5, 2007

Failure of Expected Current Account Moves...

A depreciation of the dollar should, at least theoretically, to decline in imports. However, it might not be borne out by reality. The primary reason has to do with the fact that the US has a lower exchange rate passthrough (percentage change in import prices to a 1 percentage change in exchange rates) than most OECD countries. The key issue is why does the US have an e.r.p (around 0.42 with the 1975-2003 data) that is lower than most other OECD countries. Two reasons, amongst others:
  1. By choosing the USD as a "vehicle" currency to invoice -- i.e., the sale price is fixed in USD for the importing country -- when the dollar depreciates, the sale price remains fixed in the US currency and the depreciation eats into the producer's domestic profits. Thus, this doesn't necessarily result in a decline in imports via the price mechanism.

  2. Given the assymmetric position that the US holds in the global economy (and popular imagination), when it comes to the US the producers may willingly accept lower profits. Also, given the presence of widespread substitutes available -- the exporters to USD prefer to have lower profits today than give that market share away.

Of course, in recent months -- the USD imports have declined -- but, it is useful to read this and keep the generic case argued here in mind.

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