The effects of the U.S. dollar exchange rate versus the Mexican peso are evaluated for four traded nonfarm-produced inputs (fertilizer, chemicals, farm machinery, and feed) in the U.S. Unit root tests suggest that the exchange rate and the four input price ratios support the presence of unit roots with a trend model but the presence unit roots can be rejected in the first difference model. This result is consistent with a fixed price/flex price conceptual framework, with industrial prices more likely to be unresponsive to the exchange rate than farm commodity prices.

Key Words: exchange rate, pass-through, law of one price, SUR, VAR

JEL Classifications: F14, F31, F36, F42, C23

Over the past few years, the dollar has depre- ciated against a number of currencies. In prin- ciple, the dollar's fall should help to correct the U.S. trade deficit through a fall in imports, if they are elastic. However, the dollar's recent slide has produced neither a substantial fall in imports nor a sizable shrinking of the trade imbalance. One possible explanation for the U.S. experience of the past few years is that the rate of exchange rate "pass-through" - the degree to which a change in the value of a country's currency induces a change in the price of the country's imports and exports - has fallen relative to historical values. Indeed, while pass-through is almost always "incom- plete," recent studies (Campa and Goldberg, 2005; Goldberg and Knetter, 1997) suggest that import prices in a number of industrial nations may have become progressively less responsive to changes in exchange rates over the past decade or so.

A potential decline in exchange rate passthrough has important implications for the U.S. economy. First, it has significant bearing on U.S. efforts to correct the country's trade imbalance. If import prices have become much less responsive to changes in currency values, a larger devaluation of the dollar will be needed to narrow the imbalance. Second, pass-through has implications for the stability of domestic prices. Low import prices are believed to contribute to low rates of inflation - in part by constraining domestic producers to keep their prices competitive.

Though exchange rate pass-through has long been of interest, the focus of this interest has evolved considerably over time. After a long period of debate over the law of one price (LOP) and convergence across countries, beginning in the late 1980s exchange rate passthrough studies emphasized industrial organization and the role of segmentation and price discrimination across geographically distinct product markets (Campa and Goldberg, 2006). More recently pass-through studies focused on prices of traded agricultural outputs (Ardeni, 1989; Bradshaw and Orden, 1990; Goodwin and Schroeder, 1991; Froot, Kim, and Rogoff, 1995). Adjustments of the prices of traded nonfarm-produced agricultural inputs to the exchange rate have not received as much attention. Yet these purchased inputs comprise an important component of agricultural production costs, and whether their prices also respond to exchange rate movements will affect the net impacts from currency revaluations.

Carter and Hamilton (1989) examined the validity of the law of one price (LOP) for traded inputs used in production of wheat between the closely-integrated Canadian and U.S. economies. Over the period 1977-1986, during which there were substantial movements in Canadian/U.S. currency values, Carter and Hamilton (1989) found a contemporaneous relationship between quarterly input prices, but adjustments to the LOP did not occur. Also, while Carter, Gray, and Furtan (1990) evaluated exchange rates effects on both output and input prices, most of studies focus on output prices. In their study, Carter, Gray, and Furtan (1990) used the LOP to examine the exchange rate pass-through for the prices of five Canadian inputs - petroleum, fertilizer, pesticides, machinery, and fat steers - and three Canadian outputs - wheat, canola, and feeder steers-using quarterly data over the period 1975-1988. …