1988 Reports

Some empirical evidence on hysteresis in aggregate US import prices

Baldwin, Richard

This dollar cycle, the magnitude of which is entirely unprecedented by post-war experience, has had rather puzzling effects on import prices. Historically, movements in the real exchange rate have been passed through approximately one-for-one to the real price of imports. The rising dollar of the first half of the 1980s did lead to lower real prices of imported goods, however, the two-year fall in the exchange rate has lead to only a slight increase in the real import prices. This puzzling behavior is interesting in itself. It takes on added importance, however, in that the sluggish rise of import prices has contributed to the persistence of the US trade deficit. This paper empirically investigates the hypothesis that hysteresis has occurred in US aggregate import prices. We review evidence based on standard ad hoc, pass-through equations, as well as evidence based on two structural models (the beachhead model, Baldwin 1986 and the bottleneck model, Foster and Baldwin 1986) which could account for the hysteretic behavior of import prices.