Got Milk? The Effect of Export Price Shocks on Exchange Rates
Terms of trade increases should, in theory, cause nominal exchange rate appreciations through the consumer price index (CPI) and price stickiness. However, the actual effect has remained difficult to identify and quantify empirically. This effect is of interest especially to economies that rely on the export of a single commodity; however, many of those economies may struggle to identify the casual link between exchange rates and commodity prices if they focus on potentially confounding internal factors. For example, because these countries often export a significant portion of a commodity’s world supply, domestic supply may affect the price of the commodity, and domestic CPI may affect exchange rates. This paper focuses on the dairy auctions of New Zealand, specifically the auctions of whole milk powder. The auctions provide an opportunity to find and measure shocks to external demand for the commodity, which are exogenous to the domestic economy. Similar to other settings with a primary commodity export, the auctions involve a single product that accounts for a large portion of the export price index. Therefore, when dairy prices rise in New Zealand dollar terms, the increase should have a detectable effect on the export price index and the exchange rate.