Currency Fluctuations and the Pass-through to Production and ...Presentation Transcript
Michael M. Knetter UW-Madison School of Business Manufacturing Prospects and Midwest Public Policy Federal Reserve Bank of Chicago Real Effects of Currency Fluctuations
As quoted in the Wall Street Journal… Honda Motor claims that “every ¥en the dollar rises against the Japanese currency adds about $40 million to its profits.” Does this relationship make sense? Is this a big deal or a small deal?
Price and Output Response to a Depreciation of the Exporter’s Currency quantity ¥en/$ MC MR 1 q 1 p 1 optimal price and quantity rise as a result of depreciation of the exporter’s currency for a given MC MR 2 q 2 p 2
Profit Response to a Depreciation of the Exporter’s Currency quantity ¥en MC q 2 q 1 p 2 p 1 depreciation of exporter’s currency increases price, quantity, and profit
Is this a big deal for Honda??
¥en/$ in the 1990s: Implications for Honda’s Profits 1990 to 1995: 150 ¥en/$ to 90 ¥en/$ Profit change = ($40 mill)*(-60) = -$2.4 billion 1995 to 97: 90 ¥en/$ to 125 ¥en/$ Profit change = ($40 mill)*(+35) = +$1.4 billion
Consequences of a Weaker $ for U.S. Manufacturing Sector
Reduction in costs of production relative to foreign competitors.
Higher $ prices and profit margins?
Higher production volume and employment?
Higher imported input costs?
Higher cash flows/profits.
Higher stock prices?
Less spending on lobbyists?
Determinants of PTM/Pass-Through
Potential for arbitrage.
No PTM in gold.
Lots of PTM in autos.
Who is your competition?
Local competitors may force you to keep local prices stable (lots of PTM)
Is the market regulated?
Threat of trade sanctions may lead to stable local price strategy.
How Widespread is Exposure to Currency Risk?
Indirect examples (restaurant in Miami Beach)
Foreign input sourcing
How much has the $ depreciated?
$ was worth 1.19 euros in summer 2001
$ is worth about 0.80 euros today
40% depreciation in nominal terms—approximately same in real terms
This should have large positive impact on manufacturers and farmers in the Midwest.