Exchange rate pass-through and pricing-to-market : the study of New Zealand (1988-2003)

Abstract

Previous research on pricing-to-market typically focussed on large economies and manufactured goods. This has resulted in a doubt whether pricing-to-market is a more general pattern transcending manufactured goods and large economies. In particular, since agricultural products are believed to be homogeneous, existing literature does not encourage empirical studies of agricultural exports.

Against this backdrop, this research proposes to examine the degree of pricing-to-market and exchange rate pass-through, if any, of New Zealand's pastoral exports for the period 1988-2003. We have also studied New Zealand's manufactured imports. Other issues are: (i) whether there is any meaningful relationship between New Zealand's share of an export market and the extent of pricing-to-market in that market. (ii) Whether pricing-to-market behaviour has been significantly altered by the Asian Crisis and the changes in New Zealand's trade environment around that time.

The theoretical framework is based on a Chamberlinian (1956) type model of monopolistic competition. It suggests differential pricing across export markets in response to exchange rate variation, depending on competing prices, market shares, marginal cost and expenditure on product differentiation. This model constrains the relationships among variables in equilibrium providing a testable relationship among them. Based on this, the econometric formulation models export price as a function of exchange rate and marginal cost together with the Australian price, market share and promotional expenditure in export markets. Additionally, tariffs are included as a variable in imports.

Estimation results reject the view that New Zealand is a price taker for its pastoral exports. The degree of pricing-to-market varies across products and markets. The difference in behaviour between meat and wool is partly explained by the difference in the elasticity of demand, arising from meat products facing very close substitutes, while most of New Zealand's strong wool having no close substitute. The threat of substitution by competitors' sales (Australia) and New Zealand's market shares may have been instrumental in shaping the pricing pattern in sheep meat and butter markets. Co-movement in pricing and a high degree of pricing-to-market are noted when New Zealand and Australia together dominate a market. We also observe asymmetrical behaviour before and after 1998. Exports show significant difference in pricing-to-market between New Zealand dollar appreciation and depreciation phases.

In imports to the study supports the idea that markets for industrial imports are not competitive in spite of the barrier-free trading environment of New Zealand. However, there is no symmetric effect of pass-through of exchange rate and tariffs in these markets. In the area of policy, pass-through elasticities have important implications for terms of trade, trade balance, welfare and inflation. The information can serve as background input for the Reserve Bank of New Zealand in its inflation targeting exercise.