Michael M' Knetter

1
Manufacturing Prospects and Midwest Public
PolicyFederal Reserve Bank of Chicago
Real Effects of Currency Fluctuations

• Michael M. Knetter
• UW-Madison School of Business

2
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?
3
Price and Output Response to a Depreciation of
the Exporters Currency
en/
optimal price and quantity rise as a result of
depreciation of the exporters currency for a
given MC
p1
MC
MR1
quantity
q1
4
Profit Response to a Depreciation of the
Exporters Currency
en
depreciation of exporters currency increases
price, quantity, and profit
p2
p1
MC
quantity
q2
q1
5
Is this a big deal for Honda??
6
en/ in the 1990s Implications for Hondas
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
7
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?

8
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.

9
How Widespread is Exposure to Currency Risk?

• Demand side
• Exports
• Import competition
• Indirect examples (restaurant in Miami Beach)
• Supply side
• Foreign input sourcing

10
How much has the depreciated?

• was worth 1.19 euros in summer 2001
• is worth about 0.80 euros today
• 40 depreciation in nominal termsapproximately
  same in real terms
• This should have large positive impact on
  manufacturers and farmers in the Midwest.