Manufacturing Prospects and Midwest Public Policy Federal Reserve Bank of Chicago
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Transcript of Manufacturing Prospects and Midwest Public Policy Federal Reserve Bank of Chicago
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
MR1
q1
p1
optimal price and quantityrise as a result of depreciationof the exporter’s currencyfor a given MC
MR2
q2
p2
Profit Response to a Depreciation of the Exporter’s Currency
quantity
¥en
MC
q2q1
p2
p1
depreciation of exporter’scurrency increases price, quantity, and profit
Yen/$, Monthly 1990-99
60.0090.00120.00150.00180.00
1990M1
1990M1
1991M7
1992M4
1993M1
1993M1
1994M7
1995M4
1996M1
1996M1
1997M7
1998M4
1999M1
1999M1
Is this a big deal for Honda??
¥en/$ 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?
• Demand side– Exports– Import competition– Indirect examples (restaurant in Miami Beach)
• Supply side– 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.