The exact import price and its implications for the US external imbalance

Abstract

This article calculates the Feenstra's (1994) ‘exact price index’ for each category of US-imported goods and aggregates them to analyse the US import demand equation for assessing the seriousness of the external imbalance. What distinguishes Feenstra's exact price index is that it incorporates new product varieties. The exact import price index thus calculated suggests that US conventional import prices are biased upwards. The consequent downward adjustment in import prices causes appreciation in the real exchange rate and lowers the excessive portion of imports (the difference between actual and theoretical amounts of imports obtained from the import demand equation). Since the early 2000s, however, the role that new product varieties play in lowering the excessive portion of imports has declined because the impact of new products on import prices has been outweighed by the impact of the spike in primary commodity prices, which has resulted in a substantial depreciation of the real exchange rate. It is possible that this depreciation combined with relatively large excessive imports has caused the subsequent US current account deficit to stop expansion from the late 2000s onwards.