Exchange Rates and Prices: The Case of Australian Manufactured Imports PDF
Preview Exchange Rates and Prices: The Case of Australian Manufactured Imports
Lecture Notes in Economics and Mathematical Systems 433 Jayant Menon Exchange Rates and Prices The Case of Australian Manufactured Imports Lecture Notes in Economics and Mathematical Systems 433 Founding Editors: M. Beckmann H. P. Ktinzi Editorial Board: H. Albach, M. Beckmann, G. Feichtinger, W. Hildenbrand, W. Krelle H. P. Ktinzi, K. Ritter, U. Schittko, P. Schonfeld, R. Selten Managing Editors: Prof. Dr. G. Fandel Fachbereich Wirtschaftswissenschaften Fernuniversitat Hagen Feithstr. 140/AVZ II, D-58097 Hagen, Germany Prof. Dr. W. Trockel Institut fiir Mathematischc Wirtschaftsforschung (l~IW) Universitat Bielefeld Universitatsstr. 25, D-33615 Bielefeld, Germany Springer-Verlag Berlin Heidelberg GmbH JayantMenon Exchange Rates and Prices The Case of Australian Manufactured Imports Springer Author Dr. Jayant Menon Monash University Centre of Policy Studies and The IMPACT Project Clayton, Victoria 3168 Australia "Publication of this work was assisted by a special publications grant from the University of Melbourne". Cataloging-in-Puhlication Data applied for. Die Deutsche Bibliothek - CIP-Einheitsaufnahme Menon, Jayant: Exchange rates and prices : the case of Australian manufactured imports I hy Jayant Menon. (Lecture notes in economics and mathematical systems ; 433) ISBN 978-3-540-60801-1 ISBN 978-3-642-52070-9 (eBook) DOI 10.1007/978-3-642-52070-9 NE:GT ISBN 978-3-540-60801-1 This work is subject to copyright. AII rights are reserved, whether the whole or part ofthe material is concerned, specifically the rights oftranslation. reprinting, re-use of illustrations, recitation, broadcasting, reproduction on microfilmsor in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions ofthe German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer-Verlag Berlin Heidelberg GmbH. Violations are liable for prosecution under the German Copyright Law. ~ Springer-Verlag Berlin Heidelberg 1996 Originally published by Springer-Verlag Berlin Heidelberg New York in 1996 Typesetting: Camera ready by author SPIN: 10516192 42/3140-543210 -Printed on acid-free paper In loving memory of Mrs. V.R.N. Menon and Dr. V. V. V. Menon Preface The objective of this study is to provide an in-depth analysis of the exchange rate pass-through relationship, using Australian imports of manufactures as a case study. The study begins by piecing together the theoretical literature on exchange rate pass-through, to provide the basis for the development of models for the empirical analysis. To place the empirical analysis m comparative context, a critical survey of the existing empirical literature on exchange rate pass-through is then undertaken. This is followed by a review of aspects of the structure and performance of Australian manufacturing that relate to the theme of the study. Next, the data and methodology are discussed. The analysis of exchange rate pass-through is conducted in two stages. First, it seeks to establish the degree to which Australian dollar (AUD) import prices of total manufactures and 50 product categories contained therein have responded to the massive fluctuations in the AUD during the 1980s. This is done by applying an econometric procedure which avoids the pit-falls in previous studies to a carefully assembled data set. Second, the study investigates the determinants of inter-product differences in the degree of exchange rate pass-through. This is done by relating the pass-through coefficients to a series of variables representing foreign control, quantitative restrictions (QRs), product characteristics and market structure within a cross section regression framework. A number of interesting results emerge from the analysis. First, exchange rate pass-through is incomplete for most products, with significant differences in the degree of pass-through across products. Second, recursive estimation rejected the hypotheses of the "hysteresis" effect in Australian import prices, and the asymmetric pass-through of exchange rate depreciations and appreciations in all cases. As regards the determinants of inter-product differences in pass-through, the resttlts suggest that quantitative restrictions, foreign control, concentration, product differentiation and the import share of the domestic market are negatively related to pass-through, where as the substitutability between imported and domestically produced goods is viii Exchange Rates and Prices positively related to pass-through. Our finding of incomplete pass-through has a number of implications for policy. First, the small-country assumption of international price taking behaviour seems inappropriate for most of Australia's imports. More importantly, it implies that exchange rate changes are likely to lead to real effects in the economy operating through changes in the terms of trade. Second, it brings into question the effectiveness of exchange rate policy in correcting trade deficits, since relative prices will no longer adjust as much following exchange rate changes. Third, it suggests that the inflationary (deflationary) effects of exchange rate depreciation (appreciation) will be moderated. Finally, it provides grounds to reconsider the perceived harmful effects of exchange rate volatility on international trade flows. Acknowledgments This book is based on my doctoral dissertation read at the Institute of Applied Economic and Social Research at the University of Melbourne. My biggest intellectual debt goes to my thesis supervisors, Peter Dixon and Prema Chandra Athukorala. Peter and Chandra provided invaluable advice, guidance and support throughout the duration of this research project. I am grateful for the countless evenings that they set aside to assist me with my work. Many of the ideas that went into forming this thesis were born out of discussions during these sessions. A number of people have provided detailed comments on various parts of this book which I have found very useful. I thank Robert Feinberg, Robert Phillips, Tom Taylor, Jon Kendall, Graham Dunkley and an anonymous referee of this series for their contributions in this respect. A number of people have contributed by answering various queries and/or providing comments and advice at various stages. I am grateful to Jagdish Bhagwati, Harry Bloch, Jeffrey Carmichael, Avinash Dixit, George Fane, Ross Garnaut, John Griffiths, Gabor Korosi, Brian Parmenter, Alan Powell, John Freebairn, Ross McCleod, Warwick McKibbin, Marcus Miller, Neville Norrn~n, Stephen Nickel, Tony Thirwall, Larry Sjasstad, Richard Snape and Takeshi Takayama for sparing the time to take an interest in my work. I received useful comments from participants at a number of conferences at which various parts of this book have been presented. I thank the participants from the Third International Economics Postgraduate Research Conference, 19th and 20th Conference of Economists, 1993 Meetings of the Australasian Econometric Society and the 1995 Royal Economic Society Conference. I also thank participants at seminars at Monash University and the Australian National University for their comments. For assistance with the compilation and preparation of the data base, I wish to thank Geoff Brown and Peter Cordy from the Australian Bureau of Statistics, and Tony Lawson and Paul Emery from the Industry Commission. Various data and computing problems were solved with the assistance of Catherine Baudinette and Stephen Muir. I am grateful for financial assistance received from the Institute of Applied Economic and Social Research at the University of Melbourne and the Centre of Policy Studies and IMPACT Project at Monash University for the purchase of the unpublished data used in this study. I am also grateful to the X Exchange Rates and Prices Department of Applied Economics at Victoria University, Chisholm College at LaTrobe University and the Centre of Policy Studies and IMPACT Project at Monash University for granting me study leave/time-off to complete this book. A Commonwealth scholarship released me from teaching responsibilities for one semester and this provided the most productive six month period in the writing of this book. Last but certainly not least, I wish to thank the members of my family, Mani, Geetha, Anant, Nick and Scott Narain, for their support, and for tolerating my obsession with completing this book. Publication of this work was assisted by a special publications grant from the University of Melbourne.
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