Measuring U.S. International Relative Prices: A Warp View of the World

68 Pages Posted: 11 Feb 2008

See all articles by Charles P. Thomas

Charles P. Thomas

Thomas & Son Analytics

Jaime Marquez

Board of Governors of the Federal Reserve System - International Financial Transactions Section

Sean Fahle

SUNY Buffalo, Department of Economics

Date Written: January 2008

Abstract

In this paper we construct a new measure of U.S. prices relative to those of its trading partners and use it to reexamine the behavior of U.S. net exports. Our measure differs from existing measures of the dollar's real effective exchange rate (REER) in that it explicitly incorporates both the difference in price levels between the United States and developing economies and the growing importance of these developing economies in world trade. Unlike existing REERs, our measure shows that relative U.S. prices have increased significantly over the past 15 years. In terms of simple correlations, the relationship between our measure of relative prices and U.S. net exports is much more coherent than that between existing REERs and net exports. To explore this relationship further, we use our measure to construct an index of foreign prices relevant for U.S. export volumes and reexamine several export equations. We find that export equations with the new index dominate those with previous measures in terms of in-sample fit, out-of-sample fit, and parameter constancy. In addition, we find that with the new index of foreign prices the estimated elasticity of U.S. exports with respect to foreign income is a good bit higher than the unitary elasticity found in previous studies using other price measures. This has implications for U.S. current account adjustment.

Keywords: Automated model specification, China, competitiveness, IMF, FRB, geometric aggregation, Penn World Tables, real effective exchange rates, trade elasticities

JEL Classification: C82, F41, C22

Suggested Citation

Thomas, Charles P. and Marquez, Jaime and Fahle, Sean, Measuring U.S. International Relative Prices: A Warp View of the World (January 2008). FRB International Finance Discussion Paper No. 917. Available at SSRN: https://ssrn.com/abstract=1090526 or http://dx.doi.org/10.2139/ssrn.1090526

Charles P. Thomas (Contact Author)

Thomas & Son Analytics ( email )

5409 Center St
Chevy Chase, MD 20815
United States
2022075834 (Phone)

Jaime Marquez

Board of Governors of the Federal Reserve System - International Financial Transactions Section ( email )

20th and C Streets, NW
Washington, DC 20551
United States

Sean Fahle

SUNY Buffalo, Department of Economics ( email )

415 Fronczak Hall
Buffalo, NY 14260
United States

HOME PAGE: http://economics.buffalo.edu/facultyprofiles/sean-fahle/

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