Measurement of Effective Exchange Rates Appropriate for Agricultural Trade

The paper is concerned with the effect of an exchange rate variation on agricultural trade. Most related literature has dealt with specification of economic models and empirical estimation of model parameters. In contrast, this paper concentrates on the appropriate measurement of multilateral exchange rate changes for the analysis of agricultural trade. Literature on the economic theory of index numbers was reviewed for guidance in constructing effective exchange rate indices. Major existing exchange rate indices were compared including those of the Federal Reserve Board, International Monetary Fund, Morgan Guaranty Trust, and the U.S. Department of Agriculture. New indices were constructed based on" alternative weighting schemes and index forms. In general, measurement differences among indices were not negligible and for certain periods, discrepancies were substantial. Of all the indices considered, the USDA's real trade-weighted dollar showed less appreciation of the dollar since 1980 than any of the other indices based on total trade or. agricultural trade. This raises the question of whether the USDA index understates the importance of exchange rates when large changes occur. The significance of the results is illustrated in terms of an agricultural trade model. It appears that proper measurement of the exchange rate variable may be as important as accurate measurement of parameters of the model