Unequal Welfare Gains from Trade across Countries: The Role of Aggregation and Income Elasticities

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Unequal Welfare Gains from Trade across Countries: The Role of Aggregation and Income Elasticities

One sentence summary: Equal percentage changes in home expenditure shares result in unequal gains across countries depending on their elasticity measures.

 

The corresponding academic paper by Hakan Yilmazkuday has been accepted for publication at International Economic Journal.

The working paper version is available here.

Abstract

Sectoral heterogeneity has been shown to affect country-level welfare gains from trade that can be calculated by sector-specific trade elasticities and home expenditure shares. However, empirical analyses of multi-sector models are restricted to a limited number of countries and sectors, mostly due to the lack of data on sector-specific home expenditure shares. This paper first proposes a solution to this limitation by changing the way that foreign products are aggregated at the destination country, where "unbiased" multi-sector welfare gains can be captured by using country-specific trade elasticity measures. Second, the restrictive assumption of unitary importer-income elasticity is relaxed, and it is shown that the trade elasticity in the calculation of welfare gains is replaced by the newly-introduced welfare elasticity, a function of trade and income elasticities. Empirical evidence suggests that equal percentage changes in home expenditure shares result in unequal gains across countries depending on their elasticity measures.

Non-technical Summary
Welfare gains from trade (measured as costs of autarky) can be captured by two key parameters, namely the trade elasticity and home expenditure share in a one-sector environment for a variety of models. Nevertheless, such a convenient calculation may be biased, since one-sector models ignore the interaction among sectors. It is implied that sectoral heterogeneity is accepted as a key ingredient in welfare calculations. However, when the one-sector environment is extended to a multi-sector one, due to the way that sectors are aggregated at the destination country (i.e., an upper-tier aggregation of utility across sectors), the two key parameters are required at the sector level in order to calculate welfare gains from trade; moreover, an additional/third parameter is required at the sector-level to capture sector shares. Although the trade elasticity can be estimated for pretty much any sector and any country by using the corresponding trade and price/tariff data, sector shares and sector-specific home expenditure shares are available only for certain aggregation of sectors in certain countries. Accordingly, in order to calculate welfare gains in a multi-sector environment, several studies focusing on the estimation of both parameters (at the sectoral level) have been restricted to a limited number of countries and a limited number of sectors. Moreover, when the number of countries is limited, the estimated elasticity parameters (especially those that are common across countries) simply cannot represent global trade patterns, which would lead into biased welfare calculations.

In order to address these issues, this paper changes the way that foreign products are aggregated at the destination country so that the trade elasticity and aggregate home expenditure share are enough to calculate welfare gains from trade in a multi-sector framework. This is achieved for each destination country by having an upper-tier aggregation across source countries, and a middle-tier aggregation across sectors. To ensure that the sectoral heterogeneity will still be captured after this change in the order of aggregation, we borrow the concept of "unbiased" welfare gains from the literature and consider country-specific trade elasticity measures. When this proposal is empirically tested, it is shown by the following figure that country-specific trade elasticity measures can in fact be used to obtain "unbiased" multi-sector welfare gains.

Another bias in the calculation of welfare gains may arise due to restrictive assumption of unitary importer-income elasticity. In particular, studies in the literature have shown due to source-specific importer-income elasticity measures that higher importer income results in unequal welfare gains across source countries depending on the average type of product (inferior or luxury) exported by the source country. It is implied that measuring "unbiased" welfare gains also requires the consideration of source-specific importer-income elasticity measures.

Based on this motivation, this paper considers source-specific importer-income elasticity measures by using implicitly additively separable nonhomothetic constant elasticity of substitution (CES) preferences across source countries at the upper-tier aggregation of destination utility. Such an approach is useful to separately capture the source-country-specific importer-income effects in the utility function of destination countries, without giving away the standard features of having CES preferences, so that one can easily distinguish between income and substitution effects.

Based on the discussion so far, this paper considers an upper-tier aggregation across source countries by using implicitly additively separable nonhomothetic CES preferences, a middle-tier aggregation across sectors by a Cobb-Douglas function, and a lower tier aggregation across firm-level goods by CES preferences. The implications of the model regarding trade is estimated at the bilateral country level by using UN Comtrade data between 1995-2015. Since the lower tier aggregation of individual utility is achieved across firm-level goods in the model, firm-level productivity differences are carefully connected to the data on unit prices and the corresponding estimation; therefore, although firm-level data are not utilized, firm-level productivity differences are still taken into account at the aggregated level, without making any assumptions on their distribution. Due to the tiers of aggregation introduced so far, this corresponds to having a weighted average of sectoral log unit prices (measured at the six-digit Harmonized System in UN Comtrade) in the bilateral aggregate trade estimation, where the weights are simply the expenditure weights of sectors. Nevertheless, since firm-level productivity measures are carried over to the bilateral aggregate trade estimation as residuals, aggregated log unit prices become endogenous. By using the implications of the model, bilateral trade costs measured by standard gravity variables are shown to be potential instruments for aggregated unit prices in a Two-Stage Least Squares (TSLS) estimation. In this bilateral aggregate trade estimation, the coefficient in front of aggregated unit prices represents the destination-specific trade elasticity (i.e., one minus the elasticity of substitution), while the coefficient in front of log real total consumption (due to having non-unitary income elasticity) represents the source-specific income elasticity; these estimates are further used to construct country-specific welfare elasticity estimates.

The corresponding welfare elasticity estimates have an average value of -5.40 across countries with a range between -7.33 and -2.99. In order to show the contribution of this paper in a clear way, the obtained welfare elasticity estimates are further compared to the common (across countries) trade elasticity estimate of about -4.95 that is obtained by the very same data set. With respect to the welfare gains obtained by the welfare elasticity, the welfare gains obtained by the common trade elasticity are underestimated by up to about 14% for highly-trading or high-income countries such as Ireland, Switzerland, and Germany, while they are overestimated by up to about 9% for less-trading or low-income countries such as Congo, Aruba and Guyana. When we search for a systematic explanation for the heterogeneity of these biases across countries by using the implications of our model, we show that it is not only connected to per capita income of countries but also connected to the total trade of source countries. This heterogeneity across countries is also reflected in the calculation of global welfare gains, where they range between 6.70% and 8.38% when heterogeneity is ignored and considered, respectively. 

 

 

The corresponding academic paper by Hakan Yilmazkuday has been accepted for publication at International Economic Journal.

The working paper version is available here.

 

Estimating the Trade Elasticity over Time

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Estimating the Trade Elasticity over Time

One sentence summary: Based on a panel structural VAR approach that can distinguish between trade elasticity measures over time, short-run trade elasticity estimates (after one quarter) are about 1, medium-run trade elasticity estimates (after one year) are about 5, and long-run trade elasticity estimates (after five years) are about 7.

The corresponding paper by Hakan Yilmazkuday has been accepted for publication at Economics Letters.

The working paper version is available here.

 
Abstract

Using quarterly data on the U.S. imports from its major trading partners and the corresponding trade costs, this paper estimates the trade elasticity by using a panel structural vector autoregressive model that can distinguish between short-run versus long-run elasticity measures in a continuous way and is robust to any endogeneity problem. The estimated trade elasticity measures are highly consistent with studies in alternative literatures, suggesting a short-run value of about 1 (after one quarter), a medium-run value of about 5 (after one year), and a long-run value of about 7 (after five years).

Non-technical Summary

The main topic of investigation in international trade is the reaction of trade to changes in trade costs and thus the trade elasticity. This elasticity not only measures the effects of a trade policy change (e.g., a change in duties/tariffs) on trade but also connects the changes in home expenditure share of a country to its welfare gains from trade. Accordingly, estimating the trade elasticity is essential for a trade policy evaluation regarding the changes in trade and welfare.

Several studies in the literature have estimated the trade elasticity using the implications of static or dynamic trade models. The general agreement is the trade elasticity is lower in the short run and higher in the long run, both in calibrations and in estimations. Connected to several alternative frictions introduced by the literature, this observation has also been shown to explain several puzzles in international economics such as the international elasticity puzzle, the trade-comovement puzzle, or the missing globalization puzzle. Since trade elasticity estimates highly depend on the interaction between the variables governing dynamic patters of trade (i.e., general-equilibrium effects), it is implied that distinguishing between short-run and long-run trade elasticity measures is essential and several variables governing dynamic patters of trade are endogenously determined over time. Therefore, the causality between trade and its determinants should be taken into account in a dynamic framework in the estimation of the trade elasticity.

This paper achieves such an estimation (of the trade elasticity) by using a panel structural vector autoregression (VAR) approach that takes into account the causality and thus any potential endogeneity concerns in a dynamic framework. Theoretically, the bilateral-trade variables in the estimation are selected to be consistent with the implications of a large class of general equilibrium trade models, including quarterly data on the U.S. imports from its major trading partners, the corresponding import prices (measured at the port of the trading partner), the corresponding trade costs (including both duties/tariffs and transportation/shipment costs), and the U.S. real GDP (or the U.S. industrial production as an alternative). Empirically, the estimation of the trade elasticity is achieved by using its textbook definition, which corresponds to the total percentage changes in trade divided by the total percentage changes in trade costs. In the panel structural VAR framework, this definition corresponds to dividing the cumulative impulse response of trade to the cumulative impulse response of trade costs, both following a trade-cost shock. Since the cumulative impulse response can be estimated for any period after the shock, a continuous estimate of the trade elasticity can be achieved over time, which is a key innovation in this paper with respect to the existing literature.

The continuous estimate of the trade elasticity is connected to the existing literature by considering its value after alternative number of quarters. In particular, consistent with international finance studies that consider quarterly data in their empirical analyses, short-run trade elasticity is measured one quarter after the trade-cost shock; the estimated short-run trade elasticity is about one, on average across alternative model specifications and data used, which is highly consistent with international finance studies. Similarly, consistent with international trade studies that consider annual data in their empirical analyses, medium-run trade elasticity is measured one year after the trade-cost shock; the estimated medium-run trade elasticity is about five, on average across alternative model specifications and data used, highly consistent with international trade studies. Finally, as in economic growth studies that consider five-year intervals in their empirical analyses, long-run trade elasticity is measured five years after the trade-cost shock; the estimated long-run trade elasticity is about seven, on average across alternative model specifications and data used, highly consistent with studies that have estimated the trade elasticity over time by using implications of general-equilibrium models.

 

The corresponding paper by Hakan Yilmazkuday has been accepted for publication at Economics Letters.

The working paper version is available here.

Accounting for Trade Deficits

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Accounting for Trade Deficits

One sentence summary: Total trade deficit of a country can be decomposed into changes due to its effective terms of trade, its relative trade costs, and its macroeconomic developments with respect to its export partners.

 

The corresponding paper by Hakan Yilmazkuday has been accepted for publication at Journal of International Money and Finance.

 

The working paper version is available here.

 
Abstract

This paper proposes a decomposition for the total trade deficit of a country by using implications of a dynamic trade model. It is shown that the total trade deficit of a country can be decomposed into changes due to its effective terms of trade, its relative trade costs, and its macroeconomic developments with respect to its export partners. The implications for bilateral trade are estimated using both imports and exports data for 188 countries, and the decomposition of total trade deficit is achieved for each country. Empirical results show evidence for heterogeneity across countries regarding the decomposition of trade deficits, suggesting alternative policy tools to rebalance trade at the country level. A cross-country investigation further suggests that relative trade costs have contributed the most to the heterogeneity of trade imbalances.

Non-technical Summary

Trade deficits (defined as the difference between imports and exports) have been experienced by more than 70% of the countries around the globe between 1980-2015. Having a trade deficit is problematic, because it is simply financed by capital flows (from trade-surplus countries) of which sudden stop can be destabilizing not only at the country level but also globally; on the other hand, having a trade surplus is also problematic, because trade-surplus countries may become targets for protectionist measures by trading partners. Accordingly, having a balanced trade (or at least not having an excessive deficit/surplus) is desirable for any open economy, which requires the knowledge of the sources of trade deficit.

This paper investigates the sources of trade deficit by using an international trade approach. In particular, based on the implications of a dynamic trade model that incorporates implicitly additively separable nonhomothetic constant elasticity of substitution (CES) preferences, the trade deficit of any country is decomposed into the effects due to changes in effective terms of trade, relative trade costs, and relative macroeconomic developments. This is achieved in two steps. First, by using the implications of the dynamic trade model, bilateral imports and bilateral exports of 188 countries are estimated. As is standard in the international trade literature, these estimations result in fitted values representing bilateral trade costs, source-time fixed effects and destination-time fixed effects for both bilateral imports and bilateral exports in logs. Second, since the sum of logs is not equal to the log of sums due to Jensen's inequality (i.e., one cannot take the sum of log bilateral trade deficits to obtain log total trade deficit), the fitted values obtained from these estimations are connected to the changes in total trade deficit of each country over time by using the Taylor series of bilateral trade expressions. 

This innovation results in a decomposition of the level changes in total trade deficit of a country based on changes in its effective terms of trade (representing the difference between the weighted average of import prices and the weighted average of export prices), changes in relative trade costs of the country (representing the changes in the weighted average of import trade costs and the weighted average of export trade costs), and relative macroeconomic developments of the country (representing  changes in both relative economic activity and relative saving decisions with respect to its export partners). Since the sum of changes over time in the level of total trade deficit of any country is equal to its level of total trade deficit for any given period, a final decomposition can be achieved for the level of trade deficit for any country.

The empirical results suggest that each country has different patterns over time regarding the contribution of each gravity-based component in the decomposition of trade deficits, although relative trade costs followed by relative macroeconomic developments have contributed the most to the magnitude (of the trade deficit) during the sample period, on average across countries. The average OECD country has experienced a trade surplus that is mostly explained by effective terms of trade followed by relative macroeconomic developments, whereas the average non-OECD country has experienced a trade deficit that is mostly explained by relative trade costs followed by relative macroeconomic developments.

Regarding country-specific results, for example, the U.S. trade deficit is mostly explained by the positive contributions of relative trade costs followed by those of effective terms of trade. In contrast, the negative Chinese trade deficit (i.e., its trade surplus) is mostly explained by its negative effective terms of trade, despite high and positive contributions of its relative macroeconomic developments. Another interesting country is Japan of which negative trade deficit (i.e., its trade surplus) is mostly explained by its relatively negative macroeconomic developments, followed by its negative relative trade costs. 

 

The corresponding paper by Hakan Yilmazkuday has been accepted for publication at Journal of International Money and Finance.

 

The working paper version is available here. 

The Great Trade Collapse: An Evaluation of Competing Stories

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The Great Trade Collapse: An Evaluation of Competing Stories

One sentence summary: Retail inventories have contributed the most to the great trade collapse and the corresponding recovery, followed by protectionist policies, intermediate-input trade, and trade finance.

The corresponding paper by Hakan Yilmazkuday has been accepted for publication at Macroeconomic Dynamics.

The corresponding working paper is available here.

 
Abstract

The reduction in international trade has been more than the reduction in economic activity during the 2008 financial crisis, against the one-to-one relationship between them implied by standard trade models. This so-called the great trade collapse (GTC) has been investigated extensively in the literature resulting in alternative competing stories as potential explanations. By introducing and estimating a DSGE model using eighteen quarterly series from the U.S., including those that represent the competing stories, this paper evaluates the contribution of each story to GTC. The results show that retail inventories have contributed the most to the collapse and the corresponding recovery, followed by protectionist policies, intermediate-input trade, and trade finance. Productivity and demand shocks have played negligible roles.

Non-technical Summary
The reduction in international trade has been more than the reduction in economic activity during the 2008 financial crisis. This observation has been accepted as extraordinary, because its magnitude has been far larger than in previous downturns; accordingly, it has been called as the Great Trade Collapse (GTC, henceforth).

Since the relation between trade and economic activity is one to one in standard trade models (mostly implied by constant elasticity of substitution preferences in gravity-type studies), this collapse in trade has attracted attention in the recent literature, and its causes have been investigated extensively not only because the decline in trade flows relative to overall economic activity is surprisingly high but also because it has important implications for optimal policy response. Accordingly, alternative explanations have been achieved, including the dynamics of inventories, intermediate-input trade, compositional differences between traded goods and GDP, trade finance/credit, declining aggregate demand, or higher trade costs due to protectionist policies. Since most of these papers have competing stories, they have sometimes found conflicting results with each other as well. However, what if there were multiple stories contributing to GTC at the same time? If yes, what was the contribution of each story? In other words, are these stories complements of or substitutes to each other? Based on the literature introduced so far, answering these questions requires a structural estimation of a dynamic trade model with ingredients such as intermediate-input trade, inventories, protectionist policies, trade finance, and financial interactions between countries.

Accordingly, this paper introduces a dynamic stochastic general equilibrium (DSGE) trade model to create a bridge between the literatures of international trade and macroeconomics through investigating trade patterns in a dynamic framework that borrows the stories explaining GTC from the literature introduced above. The model considers individuals, manufacturers and retailers, where the latter two hold inventories of finished goods. There is a monetary authority who decides for the policy rate, although the interest rate faced by individuals (due to intertemporal choices) and manufacturers/retailers (due to financial needs, including trade finance) is subject to the country-specific risk premium. To consider compositional effects, the model distinguishes between traded versus nontraded goods, home versus foreign goods, and durable versus nondurable goods.

The model is estimated by state-of-the-art Bayesian techniques using eighteen series of quarterly data from the U.S., including durable and nondurable imports, durable and nondurable production, services versus overall consumption, prices, inventories, duties, risk premium, and wages. The estimated model is further used to decompose durable and nondurable imports into their components, representing the competing stories of intermediate-input trade, retail inventories, protectionist policies, trade finance, retail productivity shocks, and consumer demand shocks. When overall U.S. imports are considered, the results show that retail inventories have contributed the most to GTC and the corresponding recovery, followed by protectionist policies, intermediate-input trade, and trade finance. The compositional effects within imports are significant: while retail inventories are mostly responsible for the changes in durable imports, intermediate-input trade is responsible for the changes in nondurable imports. In all cases, productivity and demand shocks have played negligible roles.

 

The corresponding paper by Hakan Yilmazkuday has been accepted for publication at Macroeconomic Dynamics.

The corresponding working paper is available here.

 

 

 

Gravity Channels in Trade

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Gravity Channels in Trade

One sentence summary: Gravity variables in international trade capture the effects of indirect (rather than direct) trade costs.

The corresponding academic paper by Yulin Hou, Yun Wang and Hakan Yilmazkuday has been accepted for publication at Journal of International Trade & Economic Development.

 

Working paper version is available here.


Abstract
Gravity variables such as distance, adjacency, colony, free trade agreements or language are used to capture the effects of trade costs in empirical studies. By using actual data on trade costs, this paper decomposes the overall effects of such variables on trade into those through three gravity channels: duties/tariffs (DC), transportation-costs (TC), and dyadic-preferences (PC). As opposed to the existing literature where gravity variables act like supply shifters (through DC and TC), this paper empirically shows that they act like demand shifters (through PC). Regarding policy, it is implied that welfare-improving globalization cannot be achieved only through reductions in direct costs such as duties/tariffs or transportation costs; it is rather the globalization itself that should be promoted in order to shift the preferences of destination countries toward international products and thus reduce indirect trade costs. The results are further connected to several existing discussions in the literature, such as welfare gains from trade and the distance puzzle.


Non-technical Summary
Gravity models have been employed to connect trade flows to masses of economic activity at source and destination countries together with dyadic/gravity variables such as distance, common language, border, colonial relationship, and free trade agreements. Independent of the microfoundations, the estimated gravity equation model can be expressed in a log-linear format where log trade enters as the dependent variable, while source and destination effects together with dyadic variables representing trade costs enter as independent variables.

Within this picture, dyadic/gravity variables have been shown to be the main focus of estimations, since they are directly linked to any policy investigation due to their representation of trade costs. Although economic models imply that dyadic/gravity variables capture such trade costs, mostly corresponding to the difference between source and destination prices, it is understood in the background that these dyadic/gravity variables may also be capturing preferences in the destination country.

In this paper, we differentiate between the effects of dyadic/gravity variables on preferences and trade costs by using actual data on trade costs of U.S. imports. In particular, trade costs are defined as the difference between source and destination prices, including both duties/tariffs and transportation costs while excluding local distribution costs. Having data on trade costs (together with the standard data of trade and unit prices) directly allows us calculating the effects of dyadic/gravity variables on the measured data we have.

In order to show the contribution of this paper in a clear way, we consider two types of preferences. The first type of preferences is random (as we call it the case of "random preferences"), which is mostly the case in the literature as we show in details. When these "random preferences" are considered, the effects of gravity variables are only through direct trade costs that are embedded in destination prices. Hence, gravity variables act like supply shifters in this case (as is standard in the literature), because they are parts of the marginal costs of delivering the product to the destination country.

The second type of preferences we consider is the one that depends on dyadic/gravity variables (as we call it the case of "dyadic preferences"). These preferences constitute the main contribution of this paper. When these "dyadic preferences" are considered, the effects of gravity variables are not only through direct trade costs that are embedded in destination prices but also through preferences of individuals at the destination country (that represent indirect trade costs). Hence, in this case, gravity variables not only act like supply shifters (as is standard in the literature) but also act like demand shifters (that are new in this paper). It is implied that "dyadic preferences" in this paper represent a more general case than "random preferences" in the literature.

The model introduced in this paper is estimated separately for each type of preferences. These estimations are essential to figure out the channels through which gravity variables affect international trade. In particular, we would like to know whether gravity variables act like supply shifters or demand shifters. The estimation results show that when "random preferences" are considered, about one third of the effects of gravity variables on international trade are due to the channel of duties/tariffs, while the rest is due to the channel of transportation costs; hence, gravity variables act like supply shifters by construction in this case. In order to show the contribution of this paper, when the more general case of "dyadic preferences" is considered, virtually all the effects of dyadic/gravity variables on U.S. imports are due to preferences, while the effects through duties/tariffs and transportation costs are very small. It is implied that when the overall effects of gravity variables on international trade are considered, they are mostly through dyadic preferences, and thus gravity variables act like demand shifters (rather than supply shifters as implied by the literature).

These results have important policy implications for having a welfare-improving globalization. In particular, policy tools acting like supply shifters such as duties/tariffs or investment on transportation technologies are simply implied as not having enough impact on; it is rather the globalization itself that should be promoted in order to shift the demand preferences of destination countries toward international products.

As a supplementary exercise, we also investigate the contribution of each gravity variable to each gravity channel. In the case of both random and dyadic preferences, distance is shown to be the dominant gravity variable for the channels of duties/tariffs and transportation costs. However, for the channel of dyadic preferences that captures virtually all the effects of gravity variables on U.S. imports, the tables turn as having a common border contributes about 45.12%, followed by distance about 32.23%, colony about 13.98%, free trade agreement (FTA) about 6.91%, and language about 1.76%.

As an additional supplementary exercise, we finally investigate the contribution of each given gravity variable through alternative gravity channels. In the case of random variables, the effects of distance, common border, colonial relationship, and common language are shown to be mostly through transportation costs, whereas the effects of FTAs are through duties/tariffs. In the case of dyadic preferences though, all gravity variables are shown to be effective through the channel of dyadic-preferences rather than duties/tariffs or transportation costs.

The results are further connected to several existing discussions in the literature, such as the distance puzzle or welfare gains from trade. In particular, we show that the distance puzzle can easily be solved by decomposing the effects of distance into those due to transportation costs, duties/tariffs and dyadic preferences. Moreover, welfare gains from trade are estimated to be relatively higher in the case of dyadic preferences, which is ignored in the existing literature.

 

 

The corresponding academic paper by Yulin Hou, Yun Wang and Hakan Yilmazkuday has been accepted for publication at Journal of International Trade & Economic Development.

 

Working paper version is available here.

Daily Exchange Rate Pass-through into Micro Prices

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Daily Exchange Rate Pass-through into Micro Prices

One sentence summary: Daily exchange rate pass-through (ERPT) into micro prices of Turkish agricultural products is about 5 percent, while less perishable products have higher ERPT of about 10 percent.

The corresponding paper by Renzo Alvarez, Amin Shoja, Syed Uddin and Hakan Yilmazkuday been published at Applied Economics Letters.

The working paper version is available here.


Abstract
This paper estimates the exchange rate pass-through (ERPT) by using good-level daily data on wholesale prices of imported agricultural products, where the identification is achieved by using daily data on the domestic inflation rate. The results of standard empirical analyses are in line with existing studies that employ lower frequencies of data by showing evidence for incomplete daily ERPT of about 5 percent. The key innovation is achieved when nonlinearities in ERPT are considered, where ERPT is doubled to about 10 percent when daily nominal exchange rate changes are above 0.55 percent, daily frequencies of price change are above 3.12 percent, and storage life of a product is above 10 weeks. Important policy implications follow.


Non-technical Summary
Exchange rate pass-through (ERPT) is the standard measure used to represent the relationship between nominal exchange rates (NER) and prices of internationally traded goods. Since central banks that have the objective of price stability can intervene the exchange rate market to have full or partial control over the value of their currency, policy makers need to know how prices would react to changes in NER. Such knowledge is also essential for individual welfare through income and substitution effects, especially for small-open economies.

Within this picture, we investigate ERPT at the product-level by introducing a new data set that has two main advantages over the ones employed in the existing literature. First, we have daily wholesale price data on 52 imported agricultural products that cover the period between January 2005 and August 2015 in Turkey; to our knowledge, this is one of the few rich data sets based on daily observations of micro prices. Second, we have the corresponding daily prices for domestically produced agricultural products as well, so that the pure effects of NER changes on prices can be identified with respect to other macroeconomic developments.

Having a daily (rather than a lower frequency) investigation is essential for understanding the dynamics in the import prices of agricultural goods, because the effects of NER changes can only be investigated in a high frequency setup due to the perishable nature of these products (e.g., having a storage life of one week for raspberry). We combine the daily import price data of agricultural products with the corresponding data on NER, frequency of price change (measured over the sample period, thanks to the micro-price nature of the data) and storage life (a concept corresponding to the opposite of perishability/depreciation) to estimate ERPT, where we consider potential nonlinearities through estimated thresholds in these variables.

The results provide evidence for incomplete daily ERPT of about 5 percent, on average across agricultural products. The key innovation is achieved when nonlinearities in ERPT are considered, where ERPT is doubled to about 10 percent when daily nominal exchange rate changes are above 0.55 percent, daily frequencies of price change are above 3.12 percent, and storage life of a product is above 10 weeks. 

These results can be perceived as positive for Turkish policy makers, since low and incomplete pass-through as in this paper (i) ensures that NER shocks do not destabilize the price level and thus facilitates the prediction of future Turkish inflation, (ii) helps the stabilization of CPI inflation (targeting) rather than that of non-traded goods prices, and (iii) provides higher degrees of freedom to the monetary authority to conduct an independent policy, without having a trade-off between real stability and inflation stability, because high nominal exchange rate volatility is allowed to stabilize the real economy in face of external shocks.