One Reason Why a Weak Dollar May Not Help the Trade Deficit

This morning the BLS released an interesting tidbit of data:

The price index for overall imports rose for the third consecutive month, rising 0.2 percent in December. From December 2002-December 2003, the index was up 1.9 percent, which followed a 4.2 percent increase over the previous year.

Why is this interesting? Because the US dollar has lost around 15-20% of its value against its trading partners, which means that imports should have cost the US 15-20% more over the year. The fact that they only cost about 2% more tells us one thing: importers and/or foreign firms who sell in the US have substantially cut the price that they’re willing to accept, presumably in order to keep market share in the US.

Economists call this phenomenon “exchange rate pass-through,” and it is crucial to understanding if the weaker US dollar will help the US trade deficit. If firms selling imports in the US are accepting lower prices in order to maintain their market shares, as this report seems to suggest, then the weaker dollar will not reduce imports at all. That’s why the decline in the dollar may have less of an impact on the US’s trade balance than many think.