Tuesday, February 19, 2013

Get ya coming and going

Why exchange rate movements don't show up much in prices to the end users, (thanks to Mary Amiti, Oleg Itskhoki and Jozef Konings).  The exporters and importers are often the same guys;
...we show that in order to understand this exchange rate disconnect we have to take into account the fact that the largest exporters are also the largest importers. This is important because when exporters are hit by an exchange rate shock in their destination market, they typically face a compensating movement in the marginal costs if they are importing their intermediate inputs.
For example, an appreciation of the euro relative to the US dollar, while increasing the domestic costs of European firms (in US dollars), typically reduces their euro costs of international sourcing of intermediate inputs. This effect is most intuitive when inputs are sourced from the US but it turns out to be, in effect, more general. Why? Because empirically, the movements in the value of a country's currency are correlated across its trade partners. This natural hedging from exchange rate movements, inherent in the imports of intermediate inputs, reduces the need for exporters to adjust their export market prices.
Which has possibly dire consequences for a Eurozone in recession; 
These results imply that the international competitiveness effects of a euro devaluation are likely to turn out to be modest given the extensive international sourcing by major exporters. In addition, a weaker euro is likely to have limited effects on prices and quantities, with the changes largely reflected in the profit margins of major exporters.

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