The impact of real exchange rate fluctations on employment and wages in eighteen different manufacturing industries in the United States: An error correction model approach analysis

This dissertation discusses the effects of exchange rate volatility on wages and employment in 18 different U.S. manufacturing industries with an error correction model approach. Innovative from prior research, this research project is more industry-specific. The implication of exchange rate fluctuations for the labor market is indeterminate. On one hand, domestic currency depreciation facilitates a firm’s exports and thus increases its wages and employment; on the other hand, currency depreciation increases a firm’s cost of production and generates loss of its profitability. Thus, a firm will experience an expansion or a contraction due to the currency depreciation. Previous studies have investigated the effect of exchange rate volatility on industry wages and employment by using the aggregate trade-weighted real exchange rate indexes— i.e., the Board of Governors of the Federal Reserve System’s broad real exchange rates and the real effective exchange rates. Because the real exchange rate indexes consider the entire U.S. trade shares, they are not specific enough to study this effect on each different industry. In order to remedy this weakness, this dissertation instead uses the trade-weighted industry-specific real exchange rate index to study this issue. This type of real exchange rate takes each trade partner of the United States in a specific sector into account; thus this study has a more precise analysis and more robust results than previous studies. In addition, this dissertation is the first study to construct the trade-weighted industry-specific real interest rate differentials and confirm the mean-reverting property of the differentials. This finding suggests that trade weights in each sector affect a firm’s profit in holding a currency. Further, this dissertation computes a new type of real exchange rate based on the trade-weighted industry-specific real interest differentials and explains how an industry’s wages and employment are affected by exchange rate movements when using this new type of exchange rate. Empirical results of this dissertation show that movements of the two types of tradeweighted industry-specific real exchange rates have a significant effect on employment and real wages, and the response differs quantitatively and qualitatively across industries. In particular, this effect is found in some of the lower markup and higher markup industries, which indicates that an industry’s pricing power in the market appears to weakly affect its growth rates of employment and wages when facing an exchange rate shock. Moreover, some of these industries generate positive responses on wages when experiencing unforeseen real dollar depreciation, which reflects the fact that wage growth has been closely related to exchange rate movements since the 1980s.