Academic journal article Atlantic Economic Journal

Exchange Rates, Import Costs, and Domestic Wage and Price Levels

Academic journal article Atlantic Economic Journal

Exchange Rates, Import Costs, and Domestic Wage and Price Levels

Article excerpt

Exchange Rates, Import Costs, and Domestic Wage and Price Levels

This paper analyzes domestic price and wage adjustments in response to changes in exchange rates and import prices. The larger the rise in money wage rates, domestic prices, and domestic currency prices of exports stemming from a currency depreciation, the smaller is the competitive advantage achieved by the country whose currency has depreciated. Both the short- and long-run effects of the changes in currency values on domestic wages and prices are investigated using a sample of quarterly pooled time-series, cross-sectional observations on seven industrial nations, i.e., United States, West Germany, Canada, Japan, United Kingdom, France, and Italy for the period 1974-82.

The major contribution of this study is the use of a system of simultaneous equations to analyze the relationships explained above. Previous empirical studies [Spitaller, JME, 1978; Goldstein, IMF No. 24, 1977; Bruno, JPE, 1978, among others] have estimated either reduced form equations or recursive models. This study uses a two-way error components model, which Baltagi [Econometrica, 1981] introduced, to estimate the following simultaneous equations model: Wc = a0 + a1 U + a2 Uc + a3 PDc + e (1) PDc = b0 + b1 Wc + b2 Lc1 + b3 PMc + v, (2) where: PM represents the import price index: W is an index of money wage rates; U is the rate of unemployment: PD is the measure of domestic prices; and L represents the index of labor productivity. …

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