PHILIPARESTIS AND WILLIAMM1LBERG
Degree of monopoly,pricing, and
flexible exchangerates
Exchange rate pass-throughis the degree to which a change in the
exchange rate is translatedinto a change in the price of internationally
tradedgoods. The pass-throughquestion took on great importancein
the United States in the 1980s with the persistence of the U.S. trade
deficit in the face of a largedepreciationof the U.S. dollar.The problem
has resurfacedfor the United States in the 1990s. In each case, some
delay in adjustmentwas expected accordingto the well-known J-curve
phenomenon. When the J-curve appearednot to be turningupward,
economistsbeganto attributethe intransigienceof the U.S. tradedeficit
in partto the rigidityof prices despite the huge currencyshift.' Explanations of these deviations from the law of one price, however, vary
widely. In this article we extend some Post Keynesianpricing models
in an effort to explain the limited pass-throughphenomenon.
The key differencebetween Post Keynesianandneoclassical theories
of pass-throughlies in their respective theories of the firm. The Post
Keynesianfirm is an oligopolist with a particularintemal structureand
set of investment requirements,based on its long-run objective of
survivalandgrowth.This firmis radicallydifferentfromthe neoclassical proprietorship,which is charactenrzedby its its short-run,profitmaximizingbehavior.Limitedexchangeratepass-throughis not easily
generatedfroma model of the neoclassicalproprietorshipwithoutsome
adhoc assumptions.Suchbehavioris,however,consistentwithstandard
Post Keynesian theories of pricing in manufacturingindustries.In the
Kalecki framework,a rise in costs for domestic or foreign firms due to
Philip Arestis is Professorat the Universityof East LondonandWilliam Milberg is
Assistant Professorat the New School for Social Research.They are gratefulto Iris
Biefang-Frisancho-Mariscal,RobertBlecker, FernandoCarvalho,JohanDeprez,
RobertFeinberg,PeterGray,Miles Groves, JanKregel, Ed NelL Bruce
Pietrykowski,Pat Smith, and Malcolm Sawyer for comments on an earlierversion of
the paper,and to Sangho Chung for his capableresearchassistance.
1 Rosenzweig and Koch (1988) arguedthatthe J-curvehad shifted, an argument
reminiscentof the shifting Phillips Curveliteratureof the 1970s.
Journal ofPost KeynesianEconomics/ Winter1993-94, Vol. 16, No. 2
167
OF POSTKEYNESIAN
ECONOMICS
168 JOURNAL
the exchangeratechangeis not fullypassedon becauseof the degree
IntheEichnermodel,a changein theexchangeratealso
of competition.
affectsthe cost of raisingfinds internallyfor futureinvestment.As a
result,the firn's investmentplansarealtered,the marlcup
is reduced,
andtheexchangerateis passedthroughonlyto a limiteddegree.
In thenextsectionwe criticallyreviewsomemainstream
modelsand
thenpresenttheEichnerianandKaleckianmodelsof limitedexchange
ratepass-through.
The sectionfollowingthatdiscussesthe Post Keynesianeconometric
modelestimatesfortheUnitedStatesandtheUnited
Kingdom.Inthefinalsectionwe concludewitha summary
of themajor
pointsandanoutlineof futureresearch.
Theoriesof limitedexchangerate pass-through
Orthodoxexplanations
ofpass-through
neoclassicaleconomistshaveoftenabandoned
Historically,
marginalist
pricinglaws for a markuppricingtheorywhenit is warranted
for the
analysisof actualeconomicconditions2
No betterexampleof thisexists
thanthe recentflurryof researchon exchangeratepass-through.
Mainstream
theoriesof limitedexchangeratepass-through
fallbroadly
intotwocategories:demand-side
andsupply-sidemodels.Thedemandside approaches
aremainlybasedon monopolisticcompetition.3
Mann
(1986),forexample,presentsa modelof monopolisticcompetitionwith
foreignproducersmeetingthe residualdemandin the U.S. market.
Dollardepreciationtranslatesdirectlyinto a cost reductionfor U.S.
producers.This, in turn,bringsincreasedmarketshareand reduced
pricesforU.S. producers.Importpricesrise,butnotin proportion
with
thedollardepreciation.4
2 Accordingto Lee(1984, 1107):"economists
periodically
resurrect
it [full-cost
p.
pricing]in orderto providea 'theoretical'
explanation
forpressingeconomicproblems,suchas inflation,thathavenotbeenadequately
handledby neoclassicalprice
theory."
3 See,forexample,Dombusch(1987),Feenstra(1989),Fisher(1989),Krugman
andBaldwin(1987),andMann(1986).Demand-side
(1987),Krugman
variantson
themonopolisticcompetition
modelareKnetter's(1989)modelof pricediscriminationandFrootandKlemperer's
(1989)game-theoretic
modelwhichconsidersmarketshareas thedeterminant
of futuredemand.
4 Thissituationis depictedin figure1. Initially,foreignfirmsmeetresidualdemand(accordingto curveRD)witi salesof Q*, whereforeignmarginalcosts(MC*)
equalmarginalrevenue(MR). TotalmarketsalesareQT0,thussalesby domestic
are(Q O- Q*). Thedollardepreciation
shiftstheU.S. supplycurveout
producers
MONOPOLY,PRICING,AND EXCHANGERATES 169
Supply-sidemodelslocate the sourceof the limitedexchangerate
in thecoststructure
of firms.Baldwin(1988a,1988b)has
pass-through
developedthe beachheadand bottleneckmodelsto explainlimited
The beachheadmodel is again one of
exchangerate pass-through.
monopolisticcompetitionbutit differsfromMann'smodelin thatit is
inentryandexitconditions.A largeexchange
is drivenbyanasymmetry
rateshockinducesentry.Reversalof theexchangerateto its initiallevel
of the home
does not causeall entrantsto exit. Thatis, appreciation
sales,
currencyreducesthemarginalcoststo foreignersof maintaining
for
This
attracts
and
networks
essential
export.
service
distribution,
entryof foreignexporters,whonow areableto coverthefixedcost of
thesenetworks.Whentheexchangeratechangeis reversed,
establishing
themarginalcostsof suchanoperationrise.Butsincetheconditionfor
exit is not the same as thatfor entry,some of the foreignfirmsthat
enteredbecauseof the exchangerate shock do not leave upon its
is thusgreaterfollowingthereversalof theshock
reversal.Competition
thaninitiallyandpricesdo notreturnto theoriginallevel.
thatmarginalcostsare
Thebottleneckmodelrelieson theassumption
atfull capacity.Firmsareassumed
constantandjumpdiscontinuously
Exchange
initiallytobeoperatingatfullcapacity.Thisis thebottleneck.
thenleadsto capacityexpansionanda pricecut. A
rateappreciation
reversalof theexchangeratechangedoesnotaltercapacity
subsequent
of marginalcosts, does not cause a
and,becauseof the discontinuity
is zeroin thiscase.5
pricerise.Pass-through
The thirdversionof the supply-sidemodellocateslimitedexchange
in adjustment
costs,thatis, theassumeddifficultyof
ratepass-through
alteringoutputin responseto exchangeratechanges.6In Kasa(1992),
(to S') thus forcing the residualdemandcurve down (to RD'). hnportsrise to Q
with marginalcosts of cl and at pricep1. The price-cost ratio, and thus the profitmargin, is reduced.Note thatchanges in demandwill also lead to changes in the profit
margin.
S The situationis depictedin figure 2. Initially the exchangerate is at eo andmarOutputis at full capacityKo,bringingprice of Pl. The exogeginal costs are mnco.
nous appreciationof the exchange rate (to el) brings a shift in the marginalcosts and
an expansionof capacity.The new marginalcost curve is mc1, at capacityK1. Sales
and outputincrease to K1 and the pass-throughis complete. If the currencysubsequentlydepreciates,say to e2, marginalcosts rise (to mw2)but due to the discontinuity of marginalcosts (reflectingincreasingretums) the price is unchangedat P1. Only
if the depreciationis very large does the importprice rise. A large depreciation,shifting marginalcosts to mc3, would bring a price rise to P3.
6 See Giovannini(1988), Kasa (1992), andMarston(1990).
ECONOMICS
170 JOURNALOF POST KEYNESIAN
Figure 1
p
foreigncurrency)
aD
Mc*
Source:Mann(1986)
for example,technologyis assumedto be associatedwit adjustment
destinationof exports.That
coststhatdifferaccordingto theparticular
is, exchangeratechangesbringdifferentialchangesin marginalcosts
in differentmarkets,which in turnleads to limitedexchangerate
pass-through
in somemarkets.
Fromtheperspectiveof PostKeynesianpricetheory,themainstream
areeitherinappropriate
oradhoc.
modelsof exchangeratepass-through
aboutthieshapeof
Thesupply-sidemodelsrelyon adhoc assumptions
tey arediscontinuous
in thiecaseof thebotteneck
costcurves,whethier
case,
costsmodel.Ineithier
intheadjustmnent
modelorlocation-specific
associte assumptionsdivergesignficantlyfromthosetraditionally
atedwithneoclassicalpricetheory.
sincetheyare
modelsareinappropriate
Themonopolisticcompetition
markuppricingmodelsonlyin thetrivialsensethattheymay, andin the
shortrunonly, resultin P > ATC.Of course,in long-runequilibrium
MONOPOLY,PRICING,AND EXCHANGERATES 171
Figure 2
P
PO
MC3
D
MR
a
K0
K1
Baldwin
Source:
(1988a)
priceneverexceedsaveragetotalcosts,whichprecludesthepossibility
of thefirmusinginternalfundsfornewinvestment.7
Whiileaveragetotal
returnontheuseof factors,
costincludesanimplicitmarket-determined
it ignores the possibilty of interal generation of funds for additional
A key featureof the alternative
view developedbelowis
investmnent.
thelinkbetweenthepricingandinvestment
decisions,andthusbetween
competition
profitsandfirmgrowthoverthelongrun.Themonopol'istic
of themarkupin the
modelis clearlynota theoryof thedetermnination
long run,but a theoryof short-runprofitmaximization.In the Post
profitmaximization
Keynesianoligopolytheoryusedbelow,short-run
withthe attaiunment
of long-runobjectives.Moremaybe 'Inconsistent
7Moreover, it implies a long-runprobabilityof entryof one, which is inconsistent
with the Post Keynesianview of the finns in an oligopoly pursuinga common price
policy. See Eichner(1980, p. 128).
172 JOURNALOF POST KEYNESIAN
ECONOMICS
over, firmsare assumedto face inelasticdemand,thusrenderingthe
modelsirrelevant.8
monopolisticcompetition
to dealwiththepass-through
Marginalist
pricingtheoryis ill-equipped
it
is
because
driven
exclusivelyby the short-runequationof
problem
marginalcostsandmarginalrevenues.Thatfirmsdonotbehavein such
a fashionbecomesmostobviouswhenlargeandsustainedchangesin
cost conditionsdo not lead to any significantchangein price.If the
is dueto changingmarkups,thenit
limitedpass-through
phenomenon
to applysomelongstandingfull-costpricing
seemsmost appropriate
models.These modelsprovidea theoryof the determination
of the
and
a
of
markup thus,potentially, coherenttheory howmarkupschange
whenexchangeratesvary.
Alternativeexplanationsof pass-through
Thetheoryof full-costpricinghas a long historyandhas alwaysbeen
at the core of Post Keynesianmicroeconomics.9
In this section we
develop theoriesof exchangerate pass-throughby extendingPost
Keynesianpricingmodels to the case of a marketwith competing
domesticandforeignfirms.We look at two basicversionsof the Post
Ineachcaseexchangeratechangeis equivalentto
Keynesianapproach.
8 Neoclassical
theoriststhemselveshave recognizedthatunderstandingpass-
Acthroughrequiresgoingbeyondthehypothesisof short-run
profitmaximization.
(1987,pp.56, 65):
cordingto Krugman
[F]irmsareforsomereasonpricingbasedon theirexpectedlong-runcosts
ratherthanon theirtemporarily
low costsduringa periodof a strongdollar.
Thepointis of courseto explainwhythefirmsshouldadoptsucha long-run
thatwhenthelags[intheefpricingrule ... It seemsintuitivelyreasonable
fectof priceson demand]arelongpricingwillbe dictatedby long-runcosts
ratherthanshort-run
fluctuations.
Mann(1986)alsohintsattheneedforanalternative
is
theoryif limitedpass-through
to be adequately
explained:
seemto haveresponded
to a dollardepreciaHistorically,
foreignproducers
tion by squeezing profitmargins;preservingmarketsharein the United States
formarketsoverseasmayinmaybe thekey to theirbehavior.... Competition
ducethemto use exchangeratechangestopricemorestrategicallyin theforeignmarket.[p.378,emphasisadded]
Thesearguments
withthetheoretical
framework
are,of course,inconsistent
adopted
in theirformalmodels,thatof short-run
profitmaximization.
9 TheearlyPostKeynesianfull-costpricingmodelswereby Kalecki(1954),
Steindl(1952),andWeintraub
(1959).Thesereliedforempiricalsupporton theseminal studiesby HallandHitch(1939)andAndrews(1949).
MONOPOLY,PRICING,AND EXCHANGERATES 173
a costincreaseforsomefinnsandnotothersintheindustry.Andineach
case limited exchangerate pass-throughis a possible outcome.In
canbe seenmosteasilywiththe
general,thePostKeynesianapproach
helpof Weintraub's
well-knownWCMpriceequation,putin termsof
of the homecurrency
foreigncurrency:P = k(W/ A)e. A depreciation
(rise in e) can be offset by a fall in k, if foreignfinrs see this as
beneficial.
strategically
Kalecki'sdegreeof monopoly
sector
Kalecki(1971a)has shownhow pricingin the manufacturing
dependson themarkupoveraveragevariablecosts andthatthefinn's
markupdependson "thedegreeof monopolyof the firm'sposition."
or
The degreeof monopolyis determinedby a set of environmental
the level of
institutionalfactors,includingindustrialconcentration,
advertisingactivities,theinfluenceof laborunions,andchangesin the
ratioof overheadto variablecosts.'0Pricesarethusbasedon a markup
overaverageprimecosts,whichareassumedconstantovertherelevant
rangeof output(i.e., thereis excess capacity).Finns also take into
accounttheaveragepricechargedby rivalfirms.Generally:
(1)
p=mu+np,
where
p
= output-weighted
averagepricein theindustry;
u
= averageprime costs;
m,n = coefficientsreflectingthedegreeof monopoly.
Inthisframework,
canbe modeledas affectexchangeratefluctuations
by the degreeof
ing primecosts. The finns' markupis detennmined
competitionamongfinns in anindustry(Kalecki,197lb):
(2)
(pi- u,)/ ui =.f ( /P,),
wherei is thefirmsubscript.
The functionft is increasingin ( /p,) becausea widerdeviation
betweenthe firm'spriceandthe averageindustrypricereflectsless
competitionamongfinns in the industryandthusis associatedwitha
10See Reynolds (1987, pp. 55-56) for a clear summaryof alternativeviews of the
concept of the degree of monopoly.
ECONOMICS
174 JOURNALOF POST KEYNESIAN
greatermarkup.If primecosts (e.g., unitlaborcosts)riseby the same
amountfor all firms in the industry,then prices for all firms rise
Theconstancyof (p /p,) in thiscaseimpliesno changein
accordingly.
themarkup.Butif costsriseforonefirmalone,theresult,say,of trade
unionstrengthatthatfinn,thenthatfiru's pricewill notincreasein the
theright-hand
asitscosts.Thiscanbe seenbyrewriting
sameproportion
sideof equation(2) in termsof costs,andrearranging:
(pi- ui) / ui = f1((l / ju,)(Xiaiu,) + (1 / n)),
(3)
where
R
= 1 - n(lia,);
ai
= (Qi / YiQ1);
i
z
=1,2,3,...,z;
= numberof firmsin theindustry.
As u,increases,competitionin theindustryrises.Thatis:
(4)
0
SB/ 8u,= d Eiaiui / AUi2)<
where B = [(1 / pu)(1,aju,) + (1 / n)].
i's markupfalls
Costs rise for firm i relativeto all firns and firmn
relativeto theaveragemarkup.
This case is analagousto thatof firmsfacingcurrencyfluctuation.
Appreciationof the foreign currencyis equivalentto an increasein its
averageprime costs relativeto those of its competitors.That is, for the
foreign firm:
(5)
Ui= cie,
where c, = averageprimecosts in the foreign countrycurrency,and e is
the price of foreign currency.Appreciationof the foreign currency(a
rise in e) raisesunit primecosts for firmsin thatcountry.Because of the
differentialcost increase,the degreeof competitionbetweenfirns is
reducedandthe markupof the foreignfirmfalls. The exchangerate
changehasbeenless thanfullypassedthroughto price.Notethatinthis
Kaleckiancase, all factors influencingthe degree of monopoly to the
same extent will be passed throughto prices to the same extent.
MONOPOLY,PRICING,AND EXCHANGERATES 175
Eichner's megacorp
Inthismodel,pricesarea functionof averagetotalcostsandtheaverage
corporatelevy, ormarkup.Thecorporatelevy is "theamountof funds
availableto themegacorpfrominternalsourcesto financeinvestment
expenditure"
(Eichner,1976,p. 61). Accordingto Eichner:
[T]hecorporatelevy is a moreusefulconceptfor understanding
oligopolistic
pricingbehavior
notionof profits].
[thantheconventional
. . . it is not simplya residualfigure,the sumleft overwhenall costs,
havebeensubtracted
fromgrossrevenue.Rather
including
dividends,
it is anamountdeliberately
decideduponby themegacorp
so thatit
willhavesufficientinternal
fundsto achieveits long-run
investment
goals. [pp.61-62]
Pricesarethendetermined
byunitcostsandtheaveragecorporate
levy:
(6)
p = AVC+ ((FC + CL)I(SORx ERG)),
where
= price;
p
AVC = averagevariablecosts;
FC = fixed costs;
CL = corporatelevy;
SOR = standardoperatingratio;
ERC = engineeringratedcapacity.
To evaluatethe overallimpacton price,we multiplythroughby the
exchangerateto putit in termsof theforeignfirm'sowncurrency:
(7)
P = [AVC+ ((FC + CL)/(ERCx SOR))]e,
wheree = thecostof foreigncurrency.
An increasein e is a depreciation
of thehomecurrency.
Thedegreeof exchangeratepass-through
thusdependsontherelative
declinein thecorporate
levy comparedwiththeexchangeratedepreciation.An exchangeratechangeaffectsnot onlythe costs butalso the
averagecorporatelevy. The relativemagnitudeof thesetwo changes
will determinethedegreeof exchangeratepass-through.
Eichnerassumesthe megacorpfaces inelasticdemandandconstant
ECONOMICS
176 JOURNALOF POST KEYNES1AN
averagecosts."1A price increase(decrease)serves, assumingagain
inelasticdemand,to increase(decrease)revenues.Giventhe constant
thepriceincreasealsoraisestheamountof funds
unitcost assumption,
We defineF as the additionalflow of funds
availableforreinvestment.
perperiodforeachdegreeof changein themarkup:
(8)
F=F(n),F'>O,F"<O.
TheF functionrisesata decreasingratedueto theincreasingimpactof
offsettingfactorsforgreaterchangesin themarkup.
Raisingfundsintemallyhasa cost,however.Priceincreasesby a firm
lead to (a) substitutionto the outputof rivalfirms,(b) the increased
likelihoodof attracting
newentrants
totheindustry,and(c)theincreased
12Thesecosts aresumthreatof meaningfulgovenmentintervention.
marizedin thefollowingfunction:
S = S(a(n),b(n),c(n)),
(9)
where
S = implicitcostof additionalinvestmentfunds;
= thesubstitution
a
effect;
b
= the entryfactor,
c
= thethreatof meaningfulgovernment
intervention.
The implicitcost (appropriately
discounted)may be calculatedas a
percentageof the revenuegain,givingan implicitinterestrate,R, the
costof raisingtheproductprice:
(10)
R = [St/ ()] * 100,
WhereS' = the discountedimplicitcostof a markupincreaseandF' =
the discountedvalueof additionalintemalfundsgeneratedperperiod
ateachmarkup.R increasesat a decreasingratewithrespectto markup
changes.
Thus,fora givenincreasein themarkup,a certainamountof revenue
will be generatedfor investment,as givenby F. Andthe markuprise
This is not for simplicity.The megacorpis usually a multiplantoperation,each
with fLxedcoefficient technology. See Eichner(1980).
12For a detailedreview of each of these factors,see Eichner(1976).
MONOPOLY,PRICING,AND EXCHANGERATES 177
has its cost, as given by the R function.These two functionsdetennine
the location of the supply curve for internallygeneratedfund, summarized in figure 3, Eichner's well-known four-quadrantdiagram.The Si
functionshows investmentfundsgeneratedper period as an increasing
functionof the implicit cost of these funds:to internallygeneratemore
funds for investment, the megacorp must bear an increasinglyhigher
cost. The model thustells us how muchthe megacorpmust raiseits price
if it is to generatea given amountof internalfunds for investmentin a
period.13Demand for investnent funds is tied to the finn objective of
long-term growth. Increasedinvestmentwill bring an increase in the
corporatelevy andin sales. The amountby which increasedinvestnent
increasesthe corporatelevy relativeto its cost is the marginalefficiency
of investment.The demandcurve for investment is thus the marginal
efficiency of investmentcurve, depictedas D in figure 3.
WithSP,S,, andD defined,we may determinethe changein the markup
consistent with megacorp objectives. At most, the markup will be
increased(decreased)up to the point where the implicit cost of such an
increase (in tenns of retainedeanings) equals the cost of borrowing
such fundsextemally. The pricingdecision thus dependson the level of
the implicitcost of raisingthe productprice,andthe
desiredinvestmnent,
interestrateon extemally boffowed funds.
The effect of an exchange rate change on prices will depend on its
impacton the conditionsfor generatingadditionalinvestmentfunds, S,
and D. Considerthe duopoly case with one foreign-countryfinn and
one home-countryfirn, each selling in the home country market. A
devaluationof the home countrycurrencyvis-A-visthe foreign-country
currencybrings a shift in the F andR functionsfor the foreign country
firn. This causes an upwardshift of Si, ceterisparibus.A given level of
funds generationwill have a highercost thanpreviouslyandthe markup
will fall. Thatis, anexchangeratedepreciationwill dampenthe markup
for the exporfingfirm-the appreciationis thusnot fully passedthrough
to the price. If demand also falls, due to a lower expected returnon
investment,then the limited exchange ratepass-throughresultholds a
fortiori.
This scenaro is depicted in figure 3, for the hypothetical case of a
Germanfirn exportingto the United States. Assume the exchange rate
13The supply curve for eternal funds,Se, is assumedperfectlyelastic. That is, we
assume the megacorpmay borrowunlimitedfunds, from banksor on the bond market, at the going rate.
178
JOURNALOF POST KEYNESIAN
ECONOMICS
Figure3
a
Rj
R, r
Si1
s
r
D
oF
fl
nl
no
-
450
F1
F0
is originally eo. Fo and Ro describe the prevailingmarketconditions,
giving Sioand markupno. Appreciationof the DM vis-a-vis the dollar
(from eoto el) leads to a downwardshift in the F curve (fromFo to F1)
andthus an upwardshift in the supplycurve of internalfunds (fromSio
to Si). The markupfalls from no to nl. The higher(intemal)cost for any
given level of funds desiredmeans the Gennan firm lowers its markup
and shifts from internalto extemal generationof additionalinvestment
funds. Of course, the magnitudeof the F curve (and thus the Si curve)
shift depends on the sensitivity of the three mitigating factors to the
exchange ratechange.The greaterthe sensitivityof fundsgenerationto
the exchange rate change, the smaller will be the markupchange and
the more limited will be the degree of exchange rate pass-thrugh.
MONOPOLY,PRICING,AND EXCHANGERATES 179
Moreover,themodelshowsmoreexplicitlythantheKaleckimodelhow
differentcomponentsof price(costs,markup)canbe associatedwitha
differentdegree of pass-through,dependingon their effect on the
long-tenninvestmentpositionof thefinn.
Someempiricalevidence
Inthissectionwe presenta modelto testthePostKeynesiantheoriesof
exchangeratepass-through
fortheUnitedKingdomandUnitedStates.
We beginby observingthatthereis a commonthreadrunningthrough
the two theorieswe havejust examined.Thisthreadis thatpricesare
determined,at least in a significantproportionof the economy,by a
processof markuponcosts.Indetenniningtheprice,firmstaketheunit
wheretheseunit
costs at anypointas given,butin anycircumstances
costs change,pnrcewill be affectedin line withthosechanges,as the
targetvariablethatfirmspursueis themarkup,notthepriceitself.We
have:
(11)
CPI = k[(AVWS)L+ (PRM)RM],
where CPI = pnrce(consumerprice index), k = markupfactor,AVWS=
averagewagesandsalaries,L = laborrequirements
perunitof output,
PRM = raw materialsprice, andRM = raw materialsrequirementsper
withrespectto time,assumingthatRM=
unitof output.Differentiating
is theinverseof the
0, andnotingthatthechangein laborrequirements
changein productivity(PROD),definedas outputper employee,it
followsthat:
(12)
CPI = k(AVWS)+ k(PRM)- k(PROD)
The effect of k, however,is expectedto be asymmetrical,in that
increasesin wages or raw materialprices will be passed on more
completelythroughincreasedpricesthanwill productivityrises into
reducedpnrces(Arestis,1986).Wemaythuswrite:
(13)
CPI = kl(AVWS)+ k2(PRM)+ c3(PROD),
0. Workingwith logarithms(indicatedby
with kl,k2> 0 and k3 &lt;
lower-caseletters)and denotingwith d "a change"in the variable
180 JOURNAL
OF POSTKEYNESIAN
ECONOMICS
concerned,we canhavealternatively:
(14)
+ a2(dprm),
+ a3(dprod)r
(dcpi),= a1(davws),
Therestof the modelbuildson an attemptto endogenize(davws)and
(dprm).We thushave:
(15)
(davws),= wl(dravws),t + w2(dcpi)',+ w3(drunemp),;
(16)
(dprm),= rl(der),+ r2(wdt),;
(17)
+ e3(nfagdp),,
(der),= el(tbrd),+ e2(cbgdp),
wherein additionto thevariablesdefinedabove,we haveravwswhich
is realavws,runempis theunemployment
rate,er is theexchangerate
(definedas$ / £),wdtistheworldvolumeof trade,tbrdfisthedifference
betweendomesticandforeigntreasurybill rate,cbgdpis the ratioof
currentbalanceto grossdomesticproduct(gdp),andnfagdpis theratio
of netforeignassetsto gdp.
Equation(14) portraysthe inflationrateas a functionof the rateof
changein averagewagesandsalaries,therateof changein thepricesof
raw materials,whereprm is the producerpriceindexcomprisingof
materialsandfuelspurchased
by themanufacturing
industry,andproboththeU.K.andU.S.
ductivity.Intermsof theestimatedrelationships,
equationsaresatisfactory.Althoughthereareexpecteddifferencesin
theestimatesforthetwocountries,especiallyin thelag structure
of the
two equations,the coefficientsbearsome similarityin termsof their
magnitudes.
PostKeynesianwageequation.It is based
Equation(15) is a standard
on the notionof the "realwageresistance"
hypothesis.Thatis to say,
whenworkers,unionizedornonunionized,
bargainforchangesin their
nominalwages,theyareinfluencedby the actualrealwageprevailing
attheendof thepreviousperiodin relationto somedesiredlevel. This
influenceis accountedfor by the variable(dravws),_.In addition,
arethoughtto be importantin
expectedinflationary
pressures(dcpO)'
of
real
asis thevariable(drunemp)
the
desired
unions,
determining
wage
which can be thoughtof as a good proxyfor the "reservearmyof
MONOPOLY,PRICING,AND EXCHANGERATES 181
Theseareimportant
differencesbetweenthetwo setsof
unemployed."
estimates.In the case of the UnitedKingdom,a numberof further
variablesprovednecessaryto be includedin the equation.Real unbenefits
emloymentbenefits
(rben)aswellaschangesinunemployment
well.Similarlyforthetworatios,long-run
(dben)performed
reasonably
morethansix months)to totalunemunemployed(thatis unemployed
ployed,andnumberof workersinvolvedin strikesto the numberof
in explainemployees.All thesevariablesaresignificantandimportant
ing (davws),as areall the diagnosticsutilized.Thewageequationfor
thanthatoftheUnitedKingdom,
theUnitedStatesis moreparsimonious
differencesin the labormarketsof the
perhapsreflectinginstitutional
two countries.
Equation(16) determinesthe rateof changeof rawmaterialsas a
functionof changesin theexchangerateandmovementsin the world
volumeof trade.Boththeestimatedcoefficientsof theU.K.andtheU.S.
equationsandtheirdiagnosticsarestatisticallysatisfactory.
The exchangerateequation(17) is constructedon the premisethat
assets,domesticandforeign,arenotperfectsubstitutes
so thatchanges
in the exchangerateareequalto interestratedifferentialsplus a risk
premium.
Theriskpremium
isproxiedbythevariables
(nfagdp)
or(cbgdp).
We mayalsothinkof thelasttwovarablesas reflectingredistributional
andannouncement
effects.A changein the ratio(nfagdp)can havean
impacton the exchangeratesinceit causesa redistribution
of wealth
betweendomesticandforeignresidents.Changesin the (cbgdp)ratio
areexpectedto haveaneffecton theexchangeratethrough"announcement"effects of unexpectedpublicationof figureson the currentaccount.Thesevariablesperformed
well statisticallyin theexchangerate
equationsforbothcountries,butin differentwaysin eachof them.The
estimatedequationfortheUnitedKingdomrequireda realinterestrate
differential(rtbrdf,thedifferencebetweenthe UnitedKingdom'sreal
billrate)to makeany
treasurybillrateto theUnitedStates'realtreasury
senseatall,whilethe(cbgdp)variabledidnotperformsatisfactorily
and
was thereforedropped.IntheU.S. caseit wasthenominalinterestrate
differential(thedifferencebetweentheU.K.treasurybill rateandthe
U.S. treasurybill rate)that performedwell, with the (nfagdp)not
producinganysensibleresultsandwas,therefore,
dropped.The(cbgdp)
vanableprovedpromisingandwasthereforeretained.
We estimatedthemodelfortheperiod1972(1Q)to 1989(2Q),using
quarterly,
seasonallyadjusteddataforthetwocountries.Theestimation
Variablemethod,and a numberof
results,using the Instrumental
182 JOURNALOF POST KEYNESIAN
ECONOMICS
in appendices
A andB. Theseindicatethatin
diagnosticsarepresented
generalthemodelperfonnswell.Themodelsforthetwocountrieswere
in anattempt
to examinetheirabilityto trackthehistorical
alsosimulated,
valuesof endogenous
variables.
Thesimulations
(availablefromthe authorson request)adequately
trackedactualvaluesandturning
points.
The modelcan serveto testthe exchangeratepass-through
theories
describedabove,usingthefollowingthreehypotheses:
(i) r,a2 < 1 for both countries;
(ii) (rla2)uK= (rla2)us;
(iii) r1a2= a, = a3 for both countries.
is less than 100
Hypothesis(i) tests if exchangeratepass-through
percent.Thisis clearlyvalidatedin oursample,as(rla)uK= 0.0094and
(rla)us = 0.0152. Hypothesis (ii) tests if pass-throughis the same in
bothcountries.Whilethisequalityis notpreciselysatisfied,thedifference is not great.Hypothesis(iii) testsif the degreeof exchangerate
pass-throughis identicalto the extentof pass-throughof the other
Thisis clearlynotthecase.
cost-sidechanges,wagesandproductivity.
Forthe UnitedKingdom,0.0094< 0.474 > 0.341 andfor the United
States0.0152<0.375 >0.001. Thisimpliesthatin theUnitedKingdom
is significantlymorelimitedthanpassexchangeratepass-through
throughof the othercost-sideinfluences.In the UnitedStates,passthroughof exchangeratechangesis less thanthatforwagechanges,but
slightlymorethanthatforproductivity
changes.Theresultsof hypotheses (i) and (ii) affirm,at least, that exchangeratepass-throughis
limited,aspredictedbybothPostKeynesiantheories.Buttheresultsof
hypothesis(iii) aresupportiveof the Eichnerratherthanthe Kalecki
model.In the latter,exchangeratechangesaretreatedas identicalto
In the Eichnermodel,wage
(non-uniforn)cost changesacrossfirmns.
changesandexchangeratechangesareexpectedto have a different
of investmentfundsandthusonthemarkupand
effectonthegeneration
tihedegreeof pass-through.14
Summaryand conclusions
TheEichnerandKaleckimarkuppricingmodelsprovidea rationalefor
ineconomiesdominated
limitedexchangeratepass-through
byoligoply
14
This result is consistentwith Sylos-Labini's(1984) study of the pass-throughof
changes in various cost componentsin a markup-pricingmodel.
MONOPOLY,PRICING,AND EXCHANGERATES 183
firms. These pricingmodels providea possible explanationof the
stubbornness
of a country'stradedeficitin responseto exchangerate
devaluation.The evidenceadducedin this articlesupportsthe limited
exchangeratepass-through
result,andis moresupportive
of theEichner
thantheKaleckimodelsinceit indicatesthattheimpactof anexchange
ratechangeis not identicalto othersourcesof cost change.Exchange
ratevariationsappearto affectthecost of intemallygeneratedinvestmentfundsandthusthemarkup.
WehavearguedthatthePostKeynesianmodelsof markuppricingare
bettersuitedto the studyof limitedexchangeratepass-through
than
orthodoxmodels.Theorthodoxmodelsmustrelyon adhocorinappropriatefoundations
to generatetheresult,whereastraditional
PostKeynesianfull-costpricingmodelsneedlittleif anyextension.
But the simplePost Keynesianmodelsare themselvesin need of
furtherdevelopment.
Forone,thePostKeynesianpricingmodelsshould
be extendedto thecaseof a multimarket
firm.Anotheraspectthatmust
be addressedis theissueof demandgrowth,as outlinedby Nell (1992).
Finally,themodelsshouldbe placedin a macrocontext,bothin order
to adequately
treattheexchangerateas endogenous,andto capturethe
issueof the cyclicalityof themarkup.Thiswouldbe especiallyuseful
in tihecontextof recentopen economystructuralist
macromodels
(BhaduriandMarglin,1990;Blecker,1989;Taylor,1991) in which
markupchangesareseentoaffectincomeandinvestnent.Thesemodels
couldpotentiallybe extendedto capturetheendogenousmarkuptheory
presentedabove.Finally,the empiricaltreatmentshouldmove from
data.
aggregateto firn- orindustry-level
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APPENDIXA: Modelestimatesfor the UnitedKingdom
Prices
(dcpi)t = 0.429(dcpi), , + 0.062(dprm)t, + 0.297(davws)t,
(4.88)
(3.97)
(5.44)
+ 0.135(davws)t,2 - 0.208(davws)t_3 + 0.148(davws)t_5
(2.53)
(3.20)
(2.91)
+ 0.103(davws)14 - 0.187(prod)t - 0.162(prod)t_2
(2.40)
(2.97)
(2.69)
1.6
R55]
.8;
=0.88;
R = 0.96;SEE= 0.006;DW= 1.96;AR[5,56]= 1.42;HT[ 18,42]=
2
PS[5] = 0.86; CH[5,56] = 0.80.
Wages
3
(davws)t= 0.471 + 0.448(davws)t_,+ 0.285(prod),- 0.246(ravws)t
(3.15)
(2.39)
-0.479(dravws)t,
(3.18)
(4.20)
(4.33)
+ 0.409(dcpi)t 3 + 0.050(dben)t,
(3.11)
(2.02)
+0.068(rben),4 + 0.107(runemp),2 - 0.21 1(runemp)$3
(2.50)
(3.17)
(3.41)
+ 0.140(runemp)t,
+0.205(runemp)t
4 - 0.317(runemp)t_5
(3.12)
(5.11)
(4.45)
+0.052(rlongun)t + 0.065(rlongun)t, + 0.003(rnowor)t 1
(2.45)
(2.97)
(1.87)
= 0.89;
R 2 0.83;SEE= 0.008;DW=2.13;AR[5,49]= 2.94;HET[30,23]
PS[5] = 0.43; CH[5,49] = 0.35.
186
JOURNAL OF POST KEYNESIAN ECONOMICS
Raw materialsprices
(dprm), = 0.239(dprm)t, + 0.494(dprm)t_4- 0. 150(der),_l
(2.86)
(6.07)
(2.12)
+ 0.740(dwdt),
(4.84)
R 2=0.61;
= 1.13;
SEE=0.0339;DW=1.55;AR[5,61]=2.21;HET[8,57]
PS[5] = 0.67; CH[5,61] = 0.62.
Exchange rate
(der), = -0.045(nfagdp), + 0.056(nfagdp)t2+
(2.30)
+ 0.646(rtbrdJ,)3-
(4.02)
(3.01)
0.537(rtbrdf),9,
(3.40)
0.70952(rtbrdjt_4
(5.37)
0.42; SEE = 0.041;DW = 1.46;AR[5,56]= 1.03;HET[8,57]= 0.97;
PS[5] = 0.94; CH[5,56] = 0.89.
R=
Diagnostics
The t-values appearin bracketsbelow the coefficients and the other
diagnosticshave the following meaning:R 2 iS the coefficient of determination;SEE is the standarderrorof the equation;DW is the DurbinWatson statistic; AR[q,T-q-k] is the qth-order F-test for residual
autocorrelationwith T as the numberof observationsandk the number
of coefficients; HET[q,T-q-k]is the F-test for heteroskedasticityquadraticin the regressors;PS[q] is is the post-sampleparameterstability
test for q quarters ahead; and CH[q,T-k-q]is the Chow F-test for
predictivefaillure over a subsetof q out of T observations.
APPENDIX B: Model estimates for the United States
Prices
(dcpi),= 0.316(dcpi), + 0.028(dprm),+ 0.046(dprm)t4
(2.96)
(2.83)
(4.26)
MONOPOLY,PRICING,AND EXCHANGERATES 187
+ 0.196(davws)t+ 0.1 13(davws)t_, + 0.094(davws)_2
(4.07)
(2.14)
(1.86)
- 0.001(prod)t4
(1.79)
R= 0.96; SEE= 0.003;DW = 2.16;AR[5,58]= 0.48;BET[14,48]= 0.48;
PS[5] = 0.18; CH[5,58] = 0.17.
Wages
(davws)t= 0.707(davws)t_4- 0.144(ravws)t, - 0.138(dravws)t3
(9.99)
(2.38)
(2.07)
+ 0.51 1(dcpOt - 0.026(runemp)t5+ 0.017(rlongun)t3
(4.04)
(3.01)
(2.95)
- 0.1 12(prod)t3 + 0.1 18(prod),5
(2.45)
(2.60)
= 0.95; SEE= 0.004;DW = 2.00;AR[5,57]= 0.66;HET[16,45]= 1.83;
PS[5] = 0.37; CH[5,57] = 0.35.
Raw materialsprices
(dprm),= 0.238(dprm)t_,+ 0.207(dwdt)t+ 0.156(dwdt)t_,
(2.00)
(2.19)
(1.77)
+ 0.150(dwdt), - 0.140(der),_ + 0.151(der),5
(1.86)
(1.84)
(1.96)
+ 0.179(der),_8
(2.24)
R2=0.51; SEE=0.035; DW=2.02; AR[5,58]=0.50; HBET[14,48]
=0.39;
PS[5] = 2.09; CH[5,58] = 1.98.
188
JOURNALOF POST KEYNESIAN
ECONOMICS
Exchangerate
(der),= -1.003(tbrdf), + 1.275(tbrdf),, - 0.469(tbrdj),4
(3.19)
(3.81)
(1.92)
- 2.955(cbgdp),4
(1.92)
R = 0.23; SEE= 0.052;DW = 1.75;AR[5,61]= 1.05;HET[8,57]= 1.38;
PS[5] = 1.83; CH[5,61] = 1.64.