Economic Research and Data

Inflation Central ~ Reading Room

 
Viewpoint - April 2005

 

Dollar Depreciation and Inflation

 

Since its peak in February 2002, the U.S. dollar has depreciated nearly 16% on average against the currencies of our most important trading partners, with surprisingly little impact on the prices of most traded goods. Oil accounts for most of the change in import prices.

 

Nominal Exchange Rate Changes, February 27, 2002-March 23, 2005

a. The Broad Dollar Index measures dollar movements against the currencies of our 26 most important trading partners. The Other Important Trading Partner Index measures dollar movements against 19 emerging market currencies. The Major Currency Index measures dollar movements against developed countries. All indexes are constructed on a trade-weighted basis.

sources

 

Dollar Depreciation and Traded Goods Prices

a. The Broad Dollar Index measures dollar movements against the currencies of our 26 most important trading partners.

sources

 

All else constant, we might expect the dollar price of foreign goods to rise, and the foreign-currency price of U.S. goods to fall by the full percentage amount of the dollar’s depreciation. Together, these price changes would shift worldwide demand away from foreign goods and toward U.S. products, eventually causing the dollar prices of all traded goods in the U.S.—imports and exports—to rise.

 

The timing and extent of these effects, however, depends heavily on the pricing strategies of large multinational firms, which can often adjust their profit margins to influence the pass-through of exchange rate changes into final product prices. Over the past 30 years, import prices have taken as long as three years to reflect exchange rate changes fully, and recent research suggests the pace is slowing. At most, export prices seem to incorporate only about three-quarters of the effect after three years.

 

The dollar’s depreciation need not generate inflation; that depends on U.S. monetary policy. Since last June, the Federal Open Market Committee has been increasing the federal funds target rate to forestall inflationary pressures. If monetary accommodation is not excessive, the consumer price indexes need not echo—even faintly— the rise in traded goods prices.

Import Price Changes since the Dollar Peak

 
Percent change,
2/02-/05
Import Prices  
  All commodities
15.2
  Food, feed, and beverages
20.5
  Industrial supplies and materials
64.3
  Captial goods
-3.0
  Automotive vehicles and parts
3.1
Consumer goods less autos
1.3
  Petroleum and petroleum products
125.4
  Nonpetroleum imports
6.4
CPI
7.9
Broad Dollar Indexa
-15.4

a. The Broad Dollar Index measures dollar movements against the currencies of our 26 most important trading partners.

sources

 

Export Price Changes since the Dollar's Peak

 
Percent change,
2/02-/05
Export Prices  
  All commodities
8.6
  Food, feed, and beverages
17.2
  Industrial supplies and materials
31.8
  Captial goods
-0.6
  Automotive vehicles and parts
2.4
  Consumer goods less autos
2.6
  Agricultural commodities
17.0
  Nonagricultural commodities
8.1
CPI
7.9
Broad Dollar Indexa
-15.4

a. The Broad Dollar Index measures dollar movements against the currencies of our 26 most important trading partners.

sources

 

Chart and Table Sources

SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and Board of Governors of the Federal Reserve System, “Foreign Exchange Rates,” Federal Reserve Statistical Releases, H.10.

 

 

The views expressed here are those of the author and not necessarily those of the Federal Reserve Bank of Cleveland , the Board of Governors of the Federal Reserve System, or its staff.