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

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, outof-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.

The impact of real exchange rate shocks on manufacturing workers: An autopsy from the MORG

“…The chief measure of the real exchange rate used in this paper is the Weighted-Average Relative Unit Labor Cost (WARULC) index, introduced by Campbell 2016ato address an index numbers problem which afflicts the RULC indexes created by the IMF (which do not include China or other developing countries), and which also affects other commonly used RER indices such as those created by the Federal Reserve. 10 We use this as trade economists have generally considered RER measures based on relative unit labor costs as being the best measures of competitiveness, while both Thomas et al (2008) and Campbell (2016a) show that the class of weighted average relative (WAR) indices outperform traditional indices in predicting trade balances, both in and out of sample. However, our results are robust to using other measures of the RER which also address the index numbers problem, such as Penn-adjusted Weighted Average Relative Prices, also provided by Campbell (2016a), or even the Federal Reserve's Broad Trade-Weighted RER Index.…”

Pass‐Through of Exchange Rates and Competition between Floaters and Fixers

“…2 2 Thomas et al (2008) argue that accounting for the rising share of trade with developing countries, and their lower relative prices, has large effects on measures of the effective exchange rate, pass‐through, and trade elasticities. …”

Fundamentals At Odds? T+L4130he U.S. Current Account Deficit and the Dollar

“…As a consequence, by the last quarter of 2007 the "unwinding" of the WARP's 1995-2002 real appreciation was only partial, with the index still 8 percent above its level in the mid-1990s. As shown in Thomas et al (2008), the WARP index does indeed track the behavior of U.S. net exports more accurately than the REER index. Chart 4 plots the non-oil balance of goods and services and the WARP index (with a 2-year lag).…”

“…For both unfiltered data (panel A) and HP-filtered cyclical data (panel B) the correlation peaks at a lag of about 8 quarters. A substantial body of empirical evidence on U.S. data corroborates this stylized fact (see, for example, Marquez, 1991, Hooper, Johnson, and Marquez, 2000and Thomas, Marquez, and Fahle, 2008. 13 As of end-September 2008, the average real effective exchange rate for the dollar during 2008 was over 10 percent more depreciated than during 2006.…”

“…A recent paper by Thomas, Marquez, and Fahle (2008) points out a weakness in commonly used real effective exchange rate indices. These (chain-weighted) indices take into account shifts in the patterns of international trade only partially-that is, they incorporate the effect of changes in trade weights on the weighted average of price and exchange rate changes in trading partners, but do not incorporate the impact of shifts in trade weights on the (weighted) average price level in trading partners.…”