Do German, Japanese, and U.S. Export prices asymmetrically respond to exchange rate changes? Evidence from aggregate data

SAEID MAHDAVI [*] This article estimates the responses (elasticity coefficients) of the export price index to appreciation and depreciation of the nominal effective exchange rate using quarterly data (1973:1-1997:2) for Japan. Germany, and the United States. Cross-county comparisons of the elasticity magnitudes based on the statistically superior of the estimated models indicate that Japanese exporters, in the aggregate, have the highest tendency to dampen the effects of exchange rate fluctuations on the foreign currency export prices in both directions by adjusting their home currency prices. Intracountry comparisons provide some evidence of an asymmetric adjustment in export prices in the cases of Japan and Germany. (JEL F31) I. INTRODUCTION The "Plaza Agreement" among the G-5 finance ministers in 1985 led to a sudden reversal of the U.S. dollar's steep climb during the first half of the 1980s. The agreement was intended to improve the large and rising U.S. trade deficits by depreciating the dollar. However, despite the dollar's equally steep fall from its peak value in 1985, subsequent improvements in the U.S. trade balance turned out to be rather sluggish. In fact, the U.S. trade deficits remained quite large in the second half of the 1980s and the 1990s. This is in sharp contrast to the large trade surpluses of Germany and Japan that persisted even in the face of appreciating (nominal and real) effective exchange rates of mark and yen over much of the modern floating period. One of the explanations for the sluggish response of the U.S. trade balance to changes in the dollar's exchange rate rests on the incomplete pass-through of the depreciation of the dollar to the U.S. import and export prices. This phenomenon is in turn explained by the dollar invoicing of some U.S. imports, currency hedging, outsourcing by some foreign exporters, and differences in markup adjustment practices between foreign and the U.S. exporters. Several authors (e.g., Kvasnick, 1986; Mann, 1986; Hervey, 1988; Ohno; 1989; Martson, 1990) emphasized the role of markup adjustment in the context of what Krugman (1987) termed the "pricing-to-market" (PTM) behavior. The latter suggests that, to keep stable the dollar price of their export, some foreign exporters use markup/ profit margins to (partially) absorb the shock of fluctuations in the exchange value of their home currency vis-a-vis the dollar. Strategic considerations such as market share in export destinations in the face of both demand and exchange rat e uncertainties may motivate this behavior. In this connection, if the foreign exporters try, for example, to maintain their market share during periods of home currency appreciation and try to increase it during periods of depreciation, then the adjustment in export prices will be asymmetric. PTM is thus expected to be more pronounced during the appreciation periods as the exporters cut the home currency prices of their exports by more than they raise them during the depreciation periods. [1] In a pioneering study, Mann (1986) provided evidence supporting profit margin adjustments of the type described above by foreign exporters over the 1977-81 period of the dollar's depreciation and the 1982-85 period of the dollar's appreciation. Mann's analysis suggested that, in the aggregate, U.S. exporters were relatively insensitive to the exchange rate changes and did not change their profit margins in either of the two periods. Interestingly enough, evidence from disaggregated data indicated that some U.S. exporters even increased their profit margins as the dollar appreciated. Subsequent studies of PTM mostly employed industry-level data. Knetter (1989) analyzed the quarterly data on the U.S. and German seven-digit export industries and found evidence of more pronounced country-specific adjustments in reaction to the exchange rate fluctuations by German exporters than U.S. exporters. Moreover, his results indicate that while such adjustments had a dampening (or stabilizing) effect on the foreign currency prices of German exports, they had an amplifying (or exacerbating) effect on foreign currency prices of U. …