Academic journal article Federal Reserve Bank of New York Economic Policy Review

Industry-Specific Exchange Rates for the United States

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Industry-Specific Exchange Rates for the United States

Article excerpt

* The effect of exchange rate movements on U.S. producers and U.S. economic activity has drawn renewed interest lately following the large declines in the trade-weighted dollar.

* At the national level, analyses of exchange rate moves often rely on aggregate trade-weighted exchange rates. However, aggregate indexes can be less effective than industry-specific indexes in capturing changes in industry competitive conditions induced by moves in specific bilateral exchange rates.

* To inform the discussions of the currency valuation changes influencing specific industries, this article constructs three industry-specific real exchange rate indexes for the United States and analyzes the extent to which each index co-moves or diverges from the aggregate economywide measures.

* The study shows how analyses that use aggregate exchange rate indexes instead of industry-specific ones might not recognize the empirical importance of exchange rates for the producer profits of specific U.S. industries.

1. INTRODUCTION

Recent significant declines in the trade-weighted U.S. dollar again raise questions about what exchange rate fluctuations mean for U.S. producers and for U.S. economic activity more broadly. When the dollar depreciates, the prices of goods imported into the United States typically rise. (1) All else equal, such exchange-rate-induced import price increases generally improve the competitiveness of U.S. producers in manufacturing and nonmanufacturing industries relative to that of foreign competitors. Although some industries are made worse off by real dollar depreciation, perhaps due to their net reliance on imported productive inputs, on average the profits of U.S. producers rise.

At the national level, discussions of exchange rate movements often rely on aggregate trade-weighted exchange rates, such as the carefully constructed measures computed by the Board of Governors of the Federal Reserve System for the aggregate economy. (2) Those aggregate indexes use weighting schemes applied to trade-partner exchange rates; the weights are based on all imports and exports of the entire U.S. economy. Such indexes are extremely useful at a macroeconomic level--for example, in discussions of the relationships between exchange rates and the aggregate trade balance. Yet this focus on national aggregates necessarily omits industry-specific distinctions concerning trade partners and competition. The importance of particular countries as competitors within an industry can differ substantially from their importance in the aggregated trade of the United States. As a consequence, aggregate trade-weighted indexes may be less effective than industry-specific real exchange rate indexes in capturing changes in industry competitive conditions induced by movements in specific bilateral exchange rates.

In this article, we demonstrate how such industry-specific real exchange rates can be constructed and present the recent paths of these indexes. We next present three basic real exchange rate measures for each industry: one using export partner weights only, a second using import partner weights, and a third using an average of export and import weights by industry. After we detail construction methods for these three industry-specific real exchange rates, we present diagnostics on the extent to which each construct co-moves or diverges from aggregate economywide measures. One basic and well-known observation is that there is a large divergence between U.S. exports and imports across country trade partners. Compared with the partners of U.S. exporters, U.S. importers tend to purchase a larger share of goods from less developed countries. Even within an industry, such differences mean that exporting producers may experience an exchange-rate-induced change in competitive conditions quite different from that of U.S. producers facing import competition or using imported components in production. …

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