Relative price changes in Japanese and U.S. manufacturing are driven by
two forces, productiviry growrh which leads to secular changes in costs and
exchange rate fluctuations which change relative prices between the two
countries. In sectors where productivity growth is high, reductions in costs
can neutralize exchange rate appreciations to keep prices competitive with
those abroad, at least in the long run, But even in these sectors, exchange
rate fluctuations are the dominant influence on relative competitiveness in the
Faced with swings in exchange rates, firms adopt defensive measures to
defend their export markets. The paper presents estimates of "pricing to
market" elasticities which suggest that firms lower their export prices in
domestic currency relative to their domestic prices in order to limit the
effects of currency appreciations. There is evidence that firms in both
countries pursue such pricing strategies, but pricing to market is more
extensive in Japan. In response to a appreciation of the yen, Japanese firms
reduce their export prices in yen sharply so as to limit the pass-through of
the appreciation into the dollar prices of their exports.
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