Large Devaluations and the Real Exchange Rate Ariel Burstein, Martin Eichenbaum, and Sergio Rebelo July 2004
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Overview • Large devaluations are associated with large declines in CPI-based real exchange rates (RER). – Rate of CPI inflation is much lower than the rate of currency devaluation.
• Fall in RER is due primarily due to slow adjustment in the price of non-traded items: – Non-traded goods, services + distribution + local goods – Relative PPP is a good description of ‘at the dock’ prices. – Prices of imported and exportable goods rise by much more ‘at the dock’ than at the retail level – Share of traded goods in consumption is small. – Behavior of CPI is dominated by the response of non-traded items. 2
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Purpose of Paper • Document these claims about the behavior of prices and RER’s after large devaluations • Contrast large devaluation episodes with ‘medium sized’ devaluations, large real appreciations and ‘small’ exchange rate fluctuations. • Briefly review theories of why the price of non-traded items change by so little after large devaluations.
3
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Empirical Analysis • Data from five large devaluation episodes – Mexico (1994), Korea (1997), Brazil (1999), Thailand (1997) and Argentina (2001).
• In depth analysis of Argentina case. – Disaggregated consumer price index (CPI) data, – Data from our own survey of prices in Buenos Aires, – Scanner data from supermarkets.
• Other Episodes – Data from 2 large real appreciations: Mexico (1988), Argentina (1991) – Data from 4 medium sized devaluations: Finland (1992), Italy (1992), Sweden (1992), UK (1992). – Data on small exchange rate fluctuations from 10 countries. 4
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Response of RER’s to Large Devaluations • Relatively small decline in CPI inflation, large decline in RER CP I RER = S · CP I ∗ • S : units of domestic currency per dollar. Country and Year Argentina - 2001 Brazil - 1999 Korea - 1997 Mexico - 1994 Thailand - 1997
Decline (log percentage change) in first year after devaluation Nominal exchange rate (effective) Real exchange rate Real GDP
108 35 37 80 36
−81 −33 −31 −43 −27
−11.6 −0.8 −6.9 −6.4 −10.7
• In all cases, rate of CPI inflation is low relative to rate of currency devaluation. 5
Structure of Consumer Price Index “Tradables”
Nontradables (health, education, housing, transportation)
Pure tradables 12.5
Local goods 12.5
50
Distribution costs
25
(retailing, wholesaling, transportation and insurance)
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Evidence on Composition of the CPI • CPI weights • Distribution Margins • Import content of consumption (direct and indirect)
Percentage Weight of Tradables in CPI Conventional Measure of Tradables Mexico 54 Korea 48 Brazil 59 Argentina 47
7
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Distribution Margins Distribution Margin by Expenditure Category (tradable goods only) Personal Consumption Country Year Expenditures Canada 1990 41 France 1995 35 Germany 1995 42 Italy 1992 43 Japan 1995 50 UK 1998 45 US 1997 43 Source: Input-Output Tables for various countries. Distribution Margin =
Retail Price - Producers Price Retail Price 8
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Importance of Imports and Exportables in Consumption • Based on input-output tables, 16 countries. – Direct import content of consumption, – Total import content of consumption. • Brazil, Korea, Mexico, and Argentina: – Direct import content of pure tradables < 5% – Total import content of consumption < 18% – Substantial heterogeneity across other 16 countries. Percentage Weight of Tradables Total Import Content of Consumption Mexico 11 Korea 18 Brazil 10 Argentina 11
Conventional Measure of Tradables 54 48 59 47 9
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Discrepancy Between the Two Measures • Standard measure of tradables (≈ 50%) based on assumption that all goods (inclusive of distribution ) are tradable and all services are nontradables. • Difference between conventional estimate of 50% and our estimates are: – Distribution services. – Local goods: those that are typically classified as tradables but are produced solely for domestic market.
10
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Retail Price of Tradables, Import / Export Prices and Exchange Rates • Consider evidence from Argentina, Brazil, Korea, Mexico and Thailand – We don’t have retail price of tradables from Thailand.
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Large Devaluations: Seff (-*) , IEPI (:o), and PT (-) , % cumulative change
Argentina
Brazil
120
50
100
40
80
30
60
20
40 10
20
0
0 102
102.5
103
103.5
99
99.5
Korea
100
100.5
Mexico
60
80
50 60
40 30
40
20 20
10 0
0 98
98.5
99
99.5
Thailand 60 50 40 30 20 10 0 97.5
98
98.5
99
95
95.5
96
96.5
Large Devaluations, Import Prices, All (-*) and Consumer (o*) Goods, % cumul. change Brazil
Thailand 70
50 60 40
50 40
30
30
20
20 10
10
0
0 99
99.5
100
100.5
97.5
98
Korea
98.5
99
Argentina
50 120 40 100 30
80
20
60 40
10
20 0
0 98
98.5
99
99.5
102
102.5
103
103.5
Price and Exchange Rate Statistics: Large Devaluations Cumulative Percent (log) Change
US$ nominal exchange Rate Trade-weighted nominal exchange rate Import Prices (at the dock) Export Prices (at the dock)
3 months 86.94 86.30 68.13 n.a.
Argentina - January 2001 6 months 12 months 24 months 128.17 123.47 107.44 123.78 108.18 105.34 111.38 111.31 99.28 n.a. n.a. n.a.
3 months 45.34 43.18 44.34 37.38
Brazil - January 1999 6 months 12 months 24 months 38.16 42.45 48.74 34.56 39.51 40.87 36.72 43.11 49.52 26.66 32.67 43.27
Consumer price index Retail price of nontradable Tradable prices
9.24 2.8 15.19
26.61 8.35 41.61
34.33 12.96 51.51
37.92 18.31 53.82
2.84 1..37 4.40
3.88 2..16 5.66
8.56 5.11 11.37
14.37 9.67 16.84
CPI-based Real Exchange Rate
78.35
99.52
80.53
79.65
40.52
31.54
32.71
30.70
Korea - September 1997 6 months 12 months 15 months 49.28 41.15 27.64 46.71 37.48 30.55 38.82 21.54 19.72 44.82 22.46 11.04
US$ nominal exchange Rate Trade-weighted nominal exchange rate Import Prices (at the dock) Export Prices (at the dock) Consumer price index Retail price of nontradable Tradable prices
2.59 2..11 3.04
6.48 5.00 8.00
6.65 6.10 8.23
7.40 4.71 10.20
8.72 6.67 10.03
26.21 21.59 29.60
39.51 31.59 45.62
64.02 53.61T 72.08
CPI-based Real Exchange Rate
43.39
39.52
30.63
24.24
42.01
31.39
42.68
24.33
US$ nominal exchange Rate Trade-weighted nominal exchange rate Import Prices (at the dock) Export Prices (at the dock)
3 months 34.23 30.54 30.07 31.36
Thailand - June 1997 6 months 12 months 15 months 56.35 49.68 35.79 46.44 36.18 28.67 50.35 40.44 20.35 47.48 32.31 17.63
Consumer price index Ret. price of nontradables Tradable prices
3.66 n.a. n.a.
5.34 n.a. n.a.
10.12 n.a. n.a.
8.92 n.a. n.a.
CPI-based Real Exchange Rate
27.45
41.37
26.50
20.75
Source: National Statistical Agencies
3 months 50.17 50.15 51.60 52.54
Mexico - December 1994 6 months 12 months 15 months 54.93 79.96 83.30 55.96 80.32 82.96 57.86 79.57 87.12 59.06 83.97 86.90
3 months 48.96 46.39 28.74 32.41
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Price Accounting • Objective: – Take inflation in non-traded objects from the data and see if we can recover the observed CPI inflation – Useful rough calculation to isolate key source of movements in RER. • With the conventional 50 percent weight for non-traded items, this calculation produces a rate of inflation much higher than observed. • Using the I/O share, we obtain rates of post-devaluation rates of inflation similar to those observed in the data
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Price Accounting... CP It = (PtT )ω (PtN )1−ω • Baseline calculation: – Measure ω using conventional weight of non-traded items in CPI basket (50%). – Measure of PN : retail price of non-traded items taken from CPI data. – Measure of PT : ∗ trade weighted exchange rate, or ∗ Import - Export Price Index • Result – implied rate of inflation, much larger than actual rate of inflation – implied fall in RER is less than actual fall in RER.
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Price Accounting: Large Devaluations Inflation One Year after Devaluation Argentina
Brazil
Korea
Mexico
108.18 57.67 22.98 31.06
39.51 25.50 8.72 8.82
37.48 20.63 10.98 6.60
80.32 57.67 36.89 39.10
111.31 59.14 23.31 31.06
37.89 14.54 8.55 8.82
22.00 13.20 8.17 6.60
81.77 58.44 37.05 39.10
Case I: PT = Trade Weighted Exchange Rate Nontradables weight = 0 Nontradables weight from CPI Nontradables weight from Input/Output Actual CPI inflation
Case II: PT = Import Export Prices Nontradables weight = 0 Nontradables weight from CPI Nontradables weight from Input/Output Actual CPI inflation
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Price Accounting... • Alternative calculation – Measure ω using total import weight of imports in consumption from Input-Output tables. – Measure PT : ∗ trade weighted exchange rate, or ∗ Import - Export Price Index
• Result – Implied rate of inflation is very similar to actual rate of inflation, fall in RER ∗ For Argentina, we actually over-shoot, implied inflation is less than actual inflation. – Implied fall in RER is similar to actual fall in RER
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Price Accounting: Large Devaluations Inflation One Year after Devaluation Argentina
Brazil
Korea
Mexico
108.18 57.67 22.98 31.06
39.51 25.50 8.72 8.82
37.48 20.63 10.98 6.60
80.32 57.67 36.89 39.10
111.31 59.14 23.31 31.06
37.89 14.54 8.55 8.82
22.00 13.20 8.17 6.60
81.77 58.44 37.05 39.10
Case I: PT = Trade Weighted Exchange Rate Nontradables weight = 0 Nontradables weight from CPI Nontradables weight from Input/Output Actual CPI inflation
Case II: PT = Import Export Prices Nontradables weight = 0 Nontradables weight CPI Nontradables weight from Input/Output Actual CPI inflation
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‘Engel Decompositions’ log(RERt) = log(CP It) − log(CP It∗) − log(St). log(RERt) =
log[PtT /(StPtT ∗)]
£ ¤ N T N∗ T∗ + (1 − ω) log(Pt /Pt ) − log(Pt /Pt ) .
• Decompose movements in the RER into: – Deviations from PPP for traded goods (PtT /(StPtT ∗)),
– Movements in the relative price of non-traded objects in the two countries ((PtN /PtT )/(PtN∗/PtT ∗)):
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How Should We Measure Price of Tradables • PtT : typically measured using retail prices of tradable goods. – Movements in log[PtT /(StPtT ∗)] large, ¤ £ N T N∗ T∗ – Movements in log(Pt /Pt ) − log(Pt /Pt ) small. • Suggests traded good prices are ‘sticky’, safe to abstract from non-traded goods. – See Engel, CKM for focus on small devaluations. • If we measure P T using CPI based retail price of tradable goods, we obtain same conclusion.
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How Much of the Decline in the RER is Due to the Decline in the Price of Tradable Goods ? (Percent as a Fraction of Change in CPI-based-RER)
3 months Retail Prices Export / Import Prices
98.96 38.30
3 months Retail Prices Export / Import Prices
96.14 4.76
Source: National Statistical Agencies
Korea - September 97 6 months 12 months 24 months 96.15 7.12
94.83 40.59
88.48 35.85
Brazil - January 99 6 months 12 months 15 months 94.37 9.37
91.41 11.89
91.95 -0.62
3 months n.a. 2.93
3 months 92.40 22.44
Thailand - June 97 6 months 12 months 24 months n.a. 3.39
n.a. 6.76
n.a. 26.67
Argentina - January 01 6 months 12 months 15 months 84.90 19.63
78.66 21.00
80.03 n.a.
3 months 96.88 -0.92
Mexico - December 94 6 months 12 months 24 months 89.18 1.53
85.70 3.55
66.90 -2.98
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Incorporating ‘At the Dock Prices’ • Selling a tradable good requires distribution services – Distribution services are produced using non-traded goods, services in competitive markets. PtT = (P¯tT )1−φ(PtN )φ where P¯tT is the price of tradable goods at the dock.
¤ £ N T¤ £ T T∗ ¯ log(RERt) = log Pt /StPt +[1−ω(1−φ)] log Pt /P¯t −(1−ω) log(PtN∗/PtT ∗) • P¯tT : average of import and export prices • PtT also reflects presence of local goods • Key£ result: Small fraction of movement in RER accounted for by changes in ¤ log P¯tT /StPtT ∗ . 20
Large Devaluations: RERCPI (-*) , RERPT (-), and RERIEPI (:o) , % cumulative change
Argentina
Brazil
100 40
80
30
60
20
40
10
20
0
0 102
102.2 102.4 102.6 102.8
103
99
99.5
Korea 50
40
40
30
30
20
20
10
10
0
0 98.5
99
99.5
Thailand 60 50 40 30 20 10 0 97.5
98
98.5
100.5
Mexico
50
98
100
99
95
95.5
96
96.5
How Much of the Decline in the RER is Due to the Decline in the Price of Tradable Goods ? (Percent as a Fraction of Change in CPI-based-RER)
3 months Retail Prices Export / Import Prices
98.96 38.30
3 months Retail Prices Export / Import Prices
96.14 4.76
Source: National Statistical Agencies
Korea - September 97 6 months 12 months 24 months 96.15 7.12
94.83 40.59
88.48 35.85
Brazil - January 99 6 months 12 months 15 months 94.37 9.37
91.41 11.89
91.95 -0.62
3 months n.a. 2.93
3 months 92.40 22.44
Thailand - June 97 6 months 12 months 24 months n.a. 3.39
n.a. 6.76
n.a. 26.67
Argentina - January 01 6 months 12 months 15 months 84.90 19.63
78.66 21.00
80.03 n.a.
3 months 96.88 -0.92
Mexico - December 94 6 months 12 months 24 months 89.18 1.53
85.70 3.55
66.90 -2.98
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Case Study: Argentina December 2001 Devaluation • Information comes from three different data sets – Disaggregated CPI data from Indec (the Argentinean National Statistical Agency); – Our own survey of prices in Buenos Aires; – Scanner data compiled by CCR, an Argentine marketing research firm. – Data we collected to identify whether goods were exported, imported or local.
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Table 3: Argentina - Disaggregated Price Statistics Cumulative Percent (log) Change December 2001 - December 2002 Price change Share in CPI log percent percent Exchange Rate Import Prices Producer Prices Consumer Prices Tradables Non-tradables
126 111 78 34 53 9
Dissagregated Tradables in CPI Imported Exportables Mixed Origin With Imported Inputs With Exportable Inputs Local Goods
83 63 72 50 45 42
Dissagregated Non-Tradables in CPI Public Services Private Services
5 15
Source: Indec
100 54 47
3 9 6 10 10 16
Table 3: Argentina - Disaggregated Price Statistics Cumulative Percent (log) Change December 2001 - December 2002 Price change log percent
Share in CPI percent
Exchange Rate Import Prices Producer Prices Consumer Prices Tradables Non-tradables
125.5 111.3 78.0 34.4 53.2 8.8
100.0 53.6 46.6
Dissagregated Tradables in CPI Imported Exportables Mixed Origin With Imported Inputs With Exportable Inputs Local Goods
83.2 62.6 71.7 49.6 44.8 41.8
3.0 8.6 5.9 10.1 9.7 16.2
Dissagregated Non-Tradables in CPI Public Services Private Services
4.7 14.7
Source: Indec
Table 4: Airfares in Argentina Airfares between Buenos Aires & other cities December 2001-December 2002 City
Price change log percent 125.53
Exchange Rate Domestic flights to: Mar de Plata Cordoba Mendoza
16.77 28.87 18.04
Montevideo Miami Santiago de Chile Madrid
128.79 109.78 113.04 116.51
International flights to:
Source: Indec
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Scanner Data • Prices and market shares of individual products at the SKU (stock keeping unit) level. – Supermarket date, purchased from CCR, 21 product categories, 1999-2002. – For product category -information on large number of individual products. ∗ e.g. have information on 1042 different types of breakfast cereal.
• Our own survey of origin of subset of individual items in CCR data set.
– 70 percent of total market share for each product category, conducted in October 2002. – Classify each product as imported, exportable, or domestic (i.e. produced solely for the domestic market).
• Cross tabulate this information with Indec data for inflation of product category. 24
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Scanner Data... • Finding (Table 5) – Positive correlation (0.7) between inflation of product category and market share of imported and exportables in product category. – Consistent with our other evidence: at retail level, inflation rates are highest for imported goods, lower for exportables, and even lower for domestic goods.
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Table 5: Inflation and Market Share of Imports and Exportables Product Category
Beer Bread Cereals Cleaning liquids Coffee Deodorant Detergents for clothes Diapers Dish Detergents Female protection Hamburgers Insect Killer Liquid Juice Mayonnaise Milk Paper Towels Shampoo Soap Soda Toothpaste Yogurt
Inflation (log percent) Dec 01 - June 02
Market Share Imported + Exportables Oct-02
32.4 33.4 40.3 50.4 45.1 50.0 67.1 83.3 50.1 67.0 17.9 53.3 50.0 64.5 41.9 52.4 47.3 46.0 31.5 67.0 27.7
12.7 52.7 55.7 86.2 55.8 86.4 66.0 72.4 32.1 85.7 0.7 77.7 11.5 95.4 0.2 50.8 71.4 70.1 3.9 68.3 4.1
Correlation coefficient: 0.69 Source: CCR, INDEC, and our own survey
Table 6: Frequency of Price Adjustment, Buenos Aires March 27 - December 24, 2002 Goods
Services
Weekly Number of Products Median Frequency of Price Adjustment (%) Median Time between Price Change
58 29.8 4.5
10 0
Monthly Number of Products Median Frequency of Price Adjustment (%) Median Time between Price Change
58 63.2 1.8
10 0
Source: Own supermarket dataset
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Our Survey of Prices in Buenos Aires • We collected weekly prices for 53 goods and 10 services (quintessential non-traded good). – Good prices collected in eight supermarkets. – Each service price was collected from one or two locations. • Goods: – apples, aspirin, bananas, band-aid, batteries, bedsheets, Big Mac, bic pen, bleach, blue jeans, bottled beer, bread, cereal, chicken, chocolate, chocolate biscuit, cigarettes, coffee, color film, computer mouse, cooking oil, two types of deodorant, diapers, diesel, diskettes, dulce de leche (a local desert), eggs, filet mignon, flour, gasoline, hake (an ocean fish), herbal tea (yerba mate), leather shoes, light bulb, mayonnaise, milk, microwave, mineral water, music CD, ossobucco, polenta, potatoes, printer, printer paper, printer toner, recordable CD, rice, shampoo, shaving blades, soft drink, spaghetti, sugar, television, toothpaste, veal scallops, wine, and writing paper. • Services: – bus fare, haircut, movie theater, newspaper, parking, pay phone, stamp, taxi, train fare, and video rental. 26
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Our Survey... Frequency of Price Adjustment, Argentina, March 27 - December 24, 2002 Goods Services Weekly Number of Products 58 10 Median Frequency of Price Adjustment (%) 29.8% 0 Median Time between Price Change 4.5 ∞ Monthly Number of Products Median Frequency of Price Adjustment (%) Median Time between Price Change
58 63.2 % 1.8
10 0% ∞
• Bils-Klenow (2003) , U.S. 1995-97. – Goods: 30% - Services: 20.7%. – Lach-Tsiddon (1992), Israel, 78-82, Average monthly frequency of price changes.: 41%
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Summarizing the Facts from ‘Large Devaluations’ • Fall in the RER due primarily to fall in price of non-traded components of CPI relative to traded goods • Relative PPP is a good description of behavior of prices ‘at the dock’. • Prices of imported and exportable goods rise by much more at the dock than at the retail level
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Evidence from Large RER Appreciations • Consider two episodes of large exchange rate appreciations – Mexico (1988 - 1994). ∗ CPI based RER appreciated by 41% ∗ CPI based RER - excluding housing - appreciated by 23% – Argentina (1991-1994) ∗ CPI based RER (peso / dollar) appreciated by 25%
• If we use retail prices of tradables (goods), – Bulk of change in RER is due to change in relative price of tradable goods • Judging by price of imports and exports in Mexico and price of imports in Argentina: relative PPP is a good approximation • Using price of imports as our measure of the price of tradables: very little of change in RER is due to fall in relative price of tradables. • As with large devaluations – Bulk of change in RER is due to change in the relative price of nontradables.
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Real Exchange Rate Appreciations, Exchange-Rate-Based Stabilizations, Argentina and Mexico (cumulative percentage change) Mexico , March 1988 - November 1994
Argentina , April 1991 - April 1994
Mex/Dollar Nominal Exchange rate
41.16
Mexico Prices Export/Import price index Consumer Price Index Goods Services less Housing Housing
56.37 106.86 79.17 121.77 160.48
US Prices Export/Import price index Consumer Price Index
12.52 25.34
CPI-based-RER CPI (excluding housing) - based RER Retail - goods - based RER Import prices - based - RER
40.35 25.37 17.20 2.69
Arg/Dollar Nominal Exchange rate
0.00
Argentina Prices Export/Import price index Consumer Price Index Goods Services
-5.64 33.47 27.02 50.54
US Prices Export/Import price index Consumer Price Index
1.22 8.63
CPI-based-RER Retail - goods - based RER Import prices - based - RER
24.83 21.85 -6.86
Price and Exchange Rate Statistics: Medium European Devaluations Cumulative Percent (log) Change
US$ nominal exchange Rate Trade-weighted nominal exchange rate Import Prices (at the dock) Export Prices (at the dock)
3 months 23.82 12.03 9.27 4.81
Finland - August 92 6 months 12 months 24 months 38.21 38.22 25.58 19.68 17.45 10.30 10.88 12.89 12.39 6.58 7.86 11.00
3 months 21.31 11.43 9.45 5.81
Italy - August 1992 6 months 12 months 24 months 33.98 37.55 36.14 20.70 21.12 26.38 14.34 12.58 17.43 12.18 13.28 16.03
Consumer price index Nontradables Tradables
0.88 0.52 1.61
1.97 0.94 3.70
2.04 1.05 4.84
3.90 3.00 7.08
1.33 1.19 1.65
2.38 2.31 2.82
4.45 4.29 5.19
8.13 7.83 9.33
CPI-based Real Exchange Rate
11.83
19.75
18.49
11.82
10.66
20.03
19.53
23.44
US$ nominal exchange Rate Trade-weighted nominal exchange rate Import Prices (at the dock) Export Prices (at the dock)
3 months 24.87 15.05 6.32 4.23
Italy - August 92 6 months 12 months 15 months 36.63 40.19 34.01 21.86 27.60 26.11 14.17 16.30 20.69 10.27 11.10 17.09
3 months 23.91 15.64 7.17 1.76
UK - August 92 6 months 12 months 15 months 29.92 26.21 22.87 17.83 11.39 13.50 12.34 12.89 18.50 11.18 12.55 15.53
Consumer price index Nontradables Tradable
0.09 -0.18 1.16
3.47 4.10 4.95
4.13 4.29 6.16
6.67 7.37 8.49
0.57 0.64 0.92
-0.07 0.32 1.82
1.71 1.81 4.82
4.09 3.06 7.95
CPI-based Real Exchange Rate
15.22
20.03
26.05
24.12
15.67
19.58
12.35
14.31
Source: National Statistical Agencies
European Medium Devaluations: Seff (-*) , IEPI (-), and PT (:) , % cumulative change Finland
Italy 30
25
25
20
20
15
15 10 10 5
5
0 -5
0 93
93.5
94
94.5
-5
93
Sweden
93.5
94
94.5
94
94.5
UK
30
20
25
15
20 10
15 10
5
5 0
0 -5
93
93.5
94
94.5
-5
93
93.5
Price Accounting: European Medium Devaluations Inflation One Year after Devaluation Finland
Italy
Sweden
UK
17.45 10.67 4.98 3.27
21.12 15.36 7.01 4.88
27.60 15.47 10.20 5.19
11.39 7.52 6.19 3.59
10.38 6.52 3.29 3.27
12.93 9.97 5.69 4.88
13.70 8.80 6.67 5.19
12.72 8.06 6.47 3.59
Case I: PT = Trade Weighted Exchange Rate Nontradables weight = 0 Nontradables weight from CPI Nontradables weight from Input/Output Actual CPI inflation
Case II: PT = Import Export Prices Nontradables weight = 0 Nontradables weight from CPI Nontradables weight from Input/Output Actual CPI inflation
European Medium Devaluations: RERCPI (-*) , RERPT (-), and RERIEPI (:o) , % cumulative change Finland
Italy
25
25
20
20
15
15
10
10
5
5
0
0
-5
93
93.5
94
94.5
-5
93
Sweden
93.5
94
94.5
94
94.5
UK
30 20
25
15
20 15
10
10 5 5 0
0 -5
93
93.5
94
94.5
-5
93
93.5
How Much of the Decline in the RER is Due to the Decline in the Price of Tradable Goods ? (Percent as a Fraction of Change in CPI-based-RER)
3 months Retail Prices Export / Import Prices
93.83 49.92
3 months Retail Prices Export / Import Prices
96.94 38.01
Source: National Statistical Agencies
Finland - August 92 6 months 12 months 24 months 91.23 73.86
84.85 60.29
73.07 41.20
Italy - August 92 6 months 12 months 15 months 97.78 40.47
96.20 47.15
94.89 48.69
3 months 92.95 73.50
3 months 99.57 74.13
Sweden - September 92 6 months 12 months 24 months 92.63 63.99
92.20 62.29
92.44 45.30
UK - August 92 6 months 12 months 15 months 97.99 34.45
99.25 -4.50
107.20 -11.62
...
Evidence from Small Devaluations • Data from countries experiencing small exchange rate devaluations – Floating exchange rates, 1997:1 - 2001:4 • Proceed as in CKM – Compute standard deviation of HP filtered exchange rate – Compute standard deviation of HP filtered RER exchange rate (CPI based and IEPI based) – Consider ratio of the two standard deviations.
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Small Devaluations, 1971:1 - 2001:4 HP Filtered Data CAN
DEN
FIN
GER
ITA
JAP
NET
SWE
UK
USA
st. dev RERCPI / st.dev. S st. dev RERIEPI / st. dev. S
1.04 0.57
1.04 0.77
1.06 0.77
1.11 0.96
0.95 0.69
1.00 0.42
1.13 0.77
0.98 0.63
1.10 0.56
1.02 0.56
sd(RERIEPI)/sd(RERCPI)
0.55
0.74
0.73
0.87
0.73
0.42
0.68
0.65
0.51
0.55
RERCPI: CPI-based-Real Exchange Rate RERIEPI: Import/Export Price - based - Real Exchange Rate S: trade-weighted nominal exchange rate
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Why do the Price of Non-Traded Items Fall by So Little After Large Devaluations? • Could this just reflect the price of government supplied, regulated goods? Cumulative Log Percentage Change in the First Year After the Devaluation Argentina∗ Brazil Korea Mexico Thailand CPI Nontradables 14.7 6.5 5.1 31.6 12.5 Public Goods Price Index 4.7 8.1 7.5 29.1 10.0
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Low Inflation in the Price of Non-Tradable Objects... • Large devaluations we studied are contractionary. • BER (2001): – Shock to private agents’ budget constraint implies country’s trade surplus must rise. – Agents reduce level of imported consumption goods. ∗ Substitute towards local tradable goods - ‘flight from quality’. – Agents reduce production, consumption of nontradable goods. ∗ Increase production of exported goods. – Marginal (dollar) cost of producing nontradable goods is increasing in output. ∗ Fall in production of nontradables induces a decline in their dollar price. ∗ Mutes post devaluation rise in domestic currency price of nontradables.
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Low Inflation in the Price of Non-Tradable Objects... • BER (2003): sticky nontradable prices can emerge as equilibrium outcome after large devaluation. – Gains from adjusting prices after change in monetary policy so small that price stickiness can be rationalized by appealing to small costs of changing prices. • Key feature of model economy – Flat marginal cost of producing output. – Elasticity of demand for output of a producer - increasing in relative price. – Share of tradable goods in consumption is small; – Domestic distribution margin for imported goods is large; – Elasticity of demand for exports is low; – Elasticity of substitution between tradables, nontradables is low.
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Basic Argument • Calculate post-devaluation equilibrium assuming price of nontradables don’t change. • Compute benefits to firms of deviating from symmetric equilibrium by changing price. • Two scenarios. – Only shock to economy: change in exchange rate, devaluation is expansionary. – Devaluation is accompanied by a reduction in net foreign assets. • After expansionary devaluation, percentage increase in profits to producer of nontradable goods who changes his price is only 0.28 percent. – PV of loss of keeping prices constant forever is only 4.7 percent. – Optimal for producer to leave price constant in presence of modest costs of changing prices. – 40 percent devaluation leads to rise in CPI of 6 percent, a drop in the RER of 34 percent. – All of decline in RER due to stickiness of NT good prices. 42
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• After contractionary devaluation: incentives to change prices is zero. – If prices were flexible, CPI would rise by 22%
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Measurement Error and the Decline in the RER • After a contractionary devaluation, flight from quality leads to downwards bias in reported CPI inflation. • Decline in RER may be overstated because the rate of inflation in retail price of tradable goods may be understated.
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