Understanding Movements in Aggregate and Product-Level Real Exchange Rates

We document new facts on international relative price movements using wholesale price data for common products sold in Canada and United States over the period 2004-2006, and information on the country of production for individual products. We find that international relative prices at the level of individual products are roughly three to four times as volatile as the Canada-US nominal exchange rate at quarterly frequencies. Aggregate real-exchange rates, constructed by averaging movements in international relative prices for individual goods, closely follow the appreciation of the Canadian dollar over this period. These patterns hold both for matched products that are locally produced in each country, as well as for goods that are produced in one

country and traded to other countries. The large movements in international relative prices for traded goods are in conflict with the hypothesis of relative purchasing power

parity, but instead point to the practice of pricing-to-market by exporters. In light of these findings, we construct a model of international trade and pricing-to-market that can account for the observed movements in product- and aggregate real-exchange rates for both traded and non-traded products. The international border plays a key role in accounting for our pricing facts by segmenting competitors across countries.

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For more information, contact Dirk Krueger.