Boston Fed, Report: Got Milk? The Effect of Export Price Shocks on Exchange Rates

“This paper provides causal evidence that terms of trade shocks do impact exchange rates. Specifically, in keeping with standard theory, export price increases cause exchange rate appreciations (and vice versa). The New Zealand setting serves as a well-identified natural experiment, but the result is important to all countries whose exports rely on a small number of commodities. As policymakers in these countries consider exchange rate policy, it is important for them to know the degree to which commodity prices will impact their exchange rate.”

“Additionally, this paper helps solve some of the exchange rate disconnect puzzle, providing evidence that a certain economic fundamental, namely the terms of trade, does causally impact exchange rates. The inability of the literature to decisively prove such relationships has slowed theoretical research in the field. This paper demonstrates how well-identified natural experiments can help advance our understanding of exchange rate determination. Seeking out additional natural experiments may be a fruitful avenue for future research.”