Mind the Gap? Fed says weak dollar may not help

Mind the Gap? Fed says weak dollar may not help A study released today by the Federal Reserve Bank of New York questions whether a weaker dollar can significantly narrow the U.S. trade deficit.
   Linda Goldberg, a vice president at the N.Y. Fed, and Eleanor Wiske Dillon, a student at the University of Michigan, write in the bank’s Current Issues in Economics and Finance
that a weaker dollar is unlikely to alter consumption patterns sufficiently to eliminate the gap between U.S. exports and imports. That gap was $759 billion in 2006, equal to 6 percent of GDP.
   In theory, they note, a dollar depreciation should raise the cost of foreign goods in the U.S. market, prompting American consumers to reduce their demand for imports. At the same time, a weaker dollar should boost foreign consumers’ purchases of U.S. goods by making them more affordable abroad.
   While acknowledging depreciation would push down the prices of U.S. exports, the authors point to three factors they believe will keep U.S. import prices from rising enough to curtail demand for foreign goods significantly:
   * Near-exclusive use of the dollar in invoicing U.S. trade. Because 93 percent of U.S. imports are invoiced in dollars, the price of most imports remains fixed for a period when the dollar depreciates.
   * While exporters to the United States may adjust their prices over time to reflect the weaker dollar, their desire to remain competitive in the large U.S. market may lead them to resist hiking prices substantially.
   * “Unusually high marketing and distribution costs added to imports once they enter the United States — costs denominated in dollars — further insulate the final consumption price of imported goods from exchange rate changes.”
   The study notes that from nation to nation there can be a big difference in exchange rate “pass-through” — the degree to which a change in the value of a country’s currency induces a change in the price of the country’s imports and exports.
   From 1975 to 2003, they estimate that for all Organization for Economic Co-operation and Development countries, a 1 percent change in the exchange rate would, on average, generate a 0.64 percent change in import prices over the course of a year.
   But the pass-through rates vary greatly by region — from complete or almost complete pass-through in Japan to 0.81 in the “euro” area, to just 0.42 percent in the United States.
   The unresponsiveness of U.S. import prices to a dollar depreciation leads Goldberg and Dillon to conclude that U.S. imports will play “only a minor role” in the easing of the U.S. trade deficit via the dollar effects channel.
   “Any substantial trade balance adjustment achieved through exchange rate changes must come instead from a reduction in export prices,” they say — that is, from a reduction in the foreign currency prices that consumers abroad pay for U.S. goods.