Monday, March 22, 2010

Another One for the Pessimists

Elasticity pessimists, that is.

Following up on the long post on Krugman and China, here's some interesting evidence on the non-responsiveness of trade flows to exchange rates. It's a study of what happens to online book prices in the US and Canada when the exchange rate between the two countries change. In theory, when the exchange rate changes, online retailers should adjust local-currency prices so a given book costs the same in both countries; if they don't, book buyers should buy from the country where prices are cheaper. As the authors say, online bookselling is "an activity where trade barriers are minimal, information is cheaply available and products are homogenous. If pervasive cross-border arbitrage was ever going to arise, it would be in sectors like online book retailing." [1]

And if pigs were ever going to fly, it would be the most svelte and limber ones.

In fact, local-currency book prices don't respond to exchange rate changes, so you get big differences in the price of books bought from, say, and (Yes, this takes shipping costs into account.) But people blithely go on on buying from their own country's site: "The fact that books in Canada become cheaper following an appreciation of the US dollar should be reflected in higher sales for Canadian retailers. Using sales rankings as proxies for quantities, we find no evidence supporting such behaviour."

Since they are real economists, they conclude that exchange rate movements need to be bigger and more persistent to affect trade. But if you're some kind of Keynesian freak, you might take this as further evidence that exchange rates just aren't that important to the current account balance.

[1] Besides these factors, online bookselling is also unusual in that the goods are bought directly from the exporting country. Most traded goods and services are sold, and therefore priced, in the importing country. So there's the additional step of pass-through to prices further reducing the impact of exchange rates.

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