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In examining how exchange rate movements affect the U.S. trade balance and the competitiveness of American producers, analysts typically focus on aggregate, or economywide, exchange rates. Yet these broad measures cannot effectively capture the changes in competitive conditions faced by individual industries when bilateral exchange rates shift.
To assess the effects of currency valuation changes on particular industries, this article constructs industry-specific real exchange rate indexes and tracks their recent paths. Using these indexes, author Linda Goldberg is able to demonstrate the differential effects of exchange rate shifts on individual industries and the economy as a whole and to establish an empirical link between changes in industry-specific exchange rates and industry profits.
The indexes developed by the author differ from the aggregate indexes in the weights assigned to trading partner currencies: In the aggregate indexes, these weights correspond to the share of each partner in the total international trade activity of the U.S. economy, while in the industry-specific indexes, they reflect the share of each partner in the U.S. exports or imports of the industry in question. This latter weighting scheme recognizes that industries have different trading partners and that the export destinations of an industry can differ sharply from the import sources of that industry's products.
For each of the thirty industries identified by two digits in the Standard Industrial Classification system, Goldberg computes three exchange rate measures—one using export partner weights only, a second using import partner weights, and a third using an average of export and import weights. She then analyzes the extent to which each of these measures co-moves with, or diverges from, aggregate exchange rates. Her finding that the percentage changes over time in industry-specific rates can differ markedly from those in aggregate exchange rates leads her to conclude that the aggregate index may substantially misrepresent the change in currency valuation for some industries.
Goldberg provides further evidence of the usefulness of the industry-specific measures when she conducts empirical tests of the relationship between U.S. producer profits and exchange rates. She shows that changes in the rates specific to particular industries have a statistically significant and noteworthy effect on the scale of industry profits.
About the Author
Linda S. Goldberg is a vice president at the Federal Reserve Bank of New York.
The views expressed in this summary are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.