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  • 1. Michael M. Knetter UW-Madison School of Business Manufacturing Prospects and Midwest Public Policy Federal Reserve Bank of Chicago Real Effects of Currency Fluctuations
  • 2. As quoted in the Wall Street Journal… Honda Motor claims that “every ¥en the dollar rises against the Japanese currency adds about $40 million to its profits.” Does this relationship make sense? Is this a big deal or a small deal?
  • 3. Price and Output Response to a Depreciation of the Exporter’s Currency quantity ¥en/$ 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
  • 4. 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
  • 5. Is this a big deal for Honda??
  • 6. ¥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
  • 7. 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?
  • 8. 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.
  • 9. How Widespread is Exposure to Currency Risk?
    • Demand side
      • Exports
      • Import competition
      • Indirect examples (restaurant in Miami Beach)
    • Supply side
      • Foreign input sourcing
  • 10. 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.