For release Jan. 11, 1996
ATLANTA FED STUDY SHOWS ONLY A WEAK LINKWhen the dollar falls against other currencies, does this drop feed U. S. inflation by pushing up prices of internationally traded goods? Not really, according to a study in the Atlanta Fed's Economic Review. Author Roberto Chang, a research officer at the Atlanta Fed, examines the empirical relationship between dollar movements and inflation in the United States. Historical evidence suggests that a falling dollar does cause inflation to increase but by a very small amount.
BETWEEN A WEAK DOLLAR AND INFLATION
Chang discusses why the inflationary effects of a weak dollar are so small. One possible answer, he reports is that when the dollar depreciates, sellers of traded goods may choose not to increase prices in response but to reduce their profit margins instead. This possibility, called pricing to market, has been scrutinized in a number of recent studies. The findings, while not conclusive, indicate that foreign firms may price to market when the dollar depreciates because they are trying to find an optimal balance between market share and profit margins.
In conclusion, Chang notes that "whether theories that explain pricing to market can be extended to macroeconomic models that yield predictions for exchange rates is a challenging, but necessary, step for fixture research."