This project has two main parts. The first part develops a model of the response of international relative prices to productivity and monetary shocks. The model will be designed to explore the potential of some new findings in international trade and shed light on some major puzzles in international macroeconomics. This model is motivated by the recent evidence uncovered in micro data on international trade that national markets for tradeable goods are in fact quite segmented. Researchers have found in manufacturing census data (manufactured goods are typically regarded as tradeable) that only a minority of manufacturing firms actually export any of their production at all. What is more, of that minority of firms that do export, they export only a small fraction of their output. These researchers and others have built models to account for these observations that assume that there are costs to trading manufactured goods internationally. This project extends a model with such costs to consider its implications for fluctuations in international relative prices. There will be three versions of the model - with perfect, Bertrand, and Cournot competition. This project will determine whether a model that matches these important observations on the pattern of trade at the micro level can account for the puzzling observation that a large fraction of the fluctuations in real exchange rates across countries can be accounted for as fluctuations in the relative price of tradeable goods. This finding in the data has attracted a lot of attention since it sharply contradicts the conventional view that the Law of One Price (or if not that, at least relative PPP) should hold for tradeable goods and hence there should be no fluctuations in the relative price of tradable goods. The project also determines whether this model can account for several important features of the data regarding fluctuations in the relative price of goods that are actually traded as measured by the export and import price indices that together make up the terms of trade. These features include the extent of pass-through and pricing-to-market and the implications of incomplete pass-through for the magnitude of the fluctuations in the terms-of-trade.
In the second part, the investigators will purchase and analyze new micro supermarket scanner data from Argentina, Brazil, and Uruguay that will allow us to examine the response of pricing and expenditure at a very disaggregated level in response to large changes in exchange rates. Large devaluations are natural laboratories where import-price pass-through, pricing to market, and switching of expenditure from imported to locally produced goods can play an important role. The investigators focus on three recent large devaluations: Argentina (December 2001), Brazil (January 1999), and Uruguay (June 2002).
Broader Impact: The behavior of international relative prices is one of the central puzzles of international macroeconomics. It is essential to develop a firm understanding of these fluctuations to evaluate monetary and exchange rate policy. This project will also develop a new micro dataset on international prices that should be useful to other researchers for a broad range of questions.
