With the rise of global value chains, many scholars have used World Input-Output Tables (WIOT) to shed light on international economic issues. These tables are useful for measuring international risk exposure (Borin et al. 2022), allocating carbon emissions across countries (Airebule et al. 2022) or examining the beneficiary of trade-generated revenue (Bohn et al. 2021).
In a recent article with Hadrien Camatte, Antoine Lalliard and Christine Rifflart (Camatte et al. 2021), we use different WIOTs to analyze cost inflation. The results of the different WIOTs converge and can be extrapolated to recent years. We show that the countries of the euro zone have a very different vulnerability to external shocks, which makes it difficult to calibrate a common monetary policy reaction to them. We analyze here both the elasticity of consumer prices in Western economies to an increase in energy prices (with a focus on an increase in Russian hydrocarbons), and the elasticity of consumer prices to variations in exchange rate.
Elasticity of consumer prices to hydrocarbon prices
The spike in commodity prices following Russia’s invasion of Ukraine has highlighted the vulnerability of Western economies to energy price inflation. According to the International Energy Agency, Russia is Europe’s largest supplier of natural gas, satisfying 34% of the region’s demand in 2021. Germany is presented as particularly vulnerable to a rise in gas prices. Russian natural gas (Afunts et al. 2022). Using the World Input-Output Database (WIOD), we illustrate which countries are most affected by an increase in energy prices. Our accounting approach aims to illustrate the interdependencies and vulnerabilities to inflation through costs. We do not intend to assess the economic impact of the war in Ukraine, as such an assessment would require extensive studies with much more sophisticated behavioral assumptions to account for product substitution and price adjustments.
Figure 1 plots the elasticity of consumer prices to an energy price shock, focusing on the impact of a shock on Russian hydrocarbon prices. The impact of a shock on Russian hydrocarbons is negligible for the United States, which is largely self-sufficient in energy and imports only 7% of its oil from Russia. The price impact is also limited for the UK, which imports less than 10% of its oil and gas from Russia. In contrast, for the Netherlands and Germany, which import about a third of their oil and gas from Russia, Russia accounts for almost 20% of the total impact of an oil price shock. energy. The impact of a rise in Russian hydrocarbon prices is even greater for Eastern European countries such as Finland, Lithuania and the Slovak Republic, which import more than 80% of their oil and gas from Russia. .
Figure 1 Vulnerability of consumer prices to an increase in hydrocarbon prices and to an increase in Russian hydrocarbon prices, WIOD
Source: Trade in Value Added (TiVA), Revision 4 (OECD 2018) and author’s calculations.
A caveat is that our calculations are based on the fourth revision of Trade in Value Added (TiVA) data, which was released in 2018 and does not represent recent changes in global trade. In the next part below, we explain how we managed to fill the data gap for the most recent years.
Elasticity of consumer prices to exchange rate changes over two decades
We move on to a more original exercise using WIOTs to illustrate how exchange rate movements affect inflation over two decades, from 1995 to 2019. The transmission of exchange rate movements differs across countries. It depends, among other things, on their respective openness to trade, the relative integration of sectors and companies into international production chains and the currency in which trade is invoiced. The originality of this analysis compared to other exercises based on the WIOT is that variations in the exchange rate have different effects on domestic and foreign prices.
Consistent with the existing literature, we find that in response to a 1% appreciation of the domestic currency, domestic consumer prices decline by around 0.10% on average globally. The impact of exchange rate changes on consumer prices has remained broadly stable over the past two decades. Our results are probably an upper limit. Indeed, our accounting approach is based on the simplifying assumption that exchange rate fluctuations are fully reflected in import prices. However, many literature suggests that pass-through is incomplete, even in the long run, due to slow nominal price adjustments or firms’ pricing behavior relative to the market. The use of alternative assumptions would therefore result in lower estimates.
Figure 2 shows that our results are robust to the use of two different datasets: OECD TiVA and WIOD (Timmer et al. 2015, 2016). We also show that an accurate assessment of the impact of exchange rate changes on consumer prices can be estimated without resorting to discounted WIOTs. The construction of WIOTs requires data and they are usually published with a lag of several years. Therefore, most WIOTs are not available for more recent years. To fill the data gap, we extrapolate the impact of exchange rate changes on consumer prices using updated GDP and trade statistics on imported consumption and intermediate goods. The dotted line in Figure 2 shows that we get a reliable estimate.
Figure 2 Elasticity of consumer prices to exchange rate shocks
Sources: WIOD, TIVA, World Bank, BACI, and Camatte et al. (2021)
Heterogeneity and channels of the effect of exchange rate changes on consumer prices
Depending on the country, the impact of a 1% fluctuation in the exchange rate on domestic prices ranges from 0.05% to 0.22%, reflecting different degrees of openness to trade and differences in foreign product content in domestic consumption. Chart 3 shows that the elasticity is lower for large advanced and developing countries. For example, we find an elasticity of 0.06 for the United States. Within the euro area, the elasticity of domestic consumer prices to fluctuations in the euro exchange rate differs considerably. It ranges from 0.07 in Italy to 0.18 in Ireland, a small open economy with a large trading sector and a large share of trade outside the euro area. For large countries (France, Germany, Italy and Spain) and countries whose trade is concentrated with euro area partners (such as Portugal and Greece), the elasticity is close to 0.10, reflecting a higher low openness to trade. The elasticity is twice as high for small open economies such as Luxembourg, Malta, Slovakia and Ireland. The value of the elasticity is closely, but not perfectly, related to the share of imported goods and services in household consumption. Overall, the higher the share of a country’s imports in consumption, the higher the elasticity of domestic consumer prices to the exchange rate.
picture 3 Elasticity of consumer prices to a domestic currency shock for 2019, extrapolated from 2014 WIOD data
To analyze the role of global value chains in transmitting exchange rate appreciation, we identify four channels through which exchange rate appreciation affects consumer prices:
- the price of imported finished products sold directly to domestic consumers;
- the price of imported inputs used in domestic production;
- the price of exported inputs fueled by imported foreign production; and
- changes in domestic and foreign production costs are in turn passed on to the price of inputs for domestic and foreign goods, leading to further changes in production costs through input-output linkages.
Figure 4 shows that the first two channels explain three-quarters of the transmission of an exchange rate variation to domestic prices. The last two channels, which reflect the impact of participation in global value chains, play a limited role, with marked heterogeneity across countries.
Figure 4 Channels of the effect of the exchange rate shock on consumer prices (WIOD 2014)
Using different WIOTs and extrapolations, we have shown the heterogeneity of countries’ vulnerability to shocks on the prices of energy products, particularly Russian ones, and to exchange rate shocks. This is a problem for the Eurozone, as it makes any common policy response difficult to calibrate. Ours is primarily an accounting exercise through a large matrix inversion. Although our accounting approach relies on a number of simplifying assumptions, the study of the heterogeneity between countries emerging from different input-output structures is an important starting point for a more complete study of inflation by the costs.
Authors’ note: The opinions expressed are those of the authors and do not necessarily reflect those of the Banque de France.
Afunts, G, M Cato, S Helmschrott and T Schmidt (2022), “Russia’s invasion of Ukraine drove up personal inflation expectations in Germany”, VoxEU.org, 20 April.
Airebule, P, H Cheng and J Ishikawa (2022), “Shared responsibility criteria for the allocation of carbon emissions between countries”, VoxEU.org, 28 February.
Bohn, T, S Brakman and E Dietzenbacher (2021), “From gross exports to value-added exports to revenue exports”, VoxEU.org, 15 June.
Borin, A, M Mancini and D Taglioni (2022), “Integrating if global value chains might not increase risk exposure after all”, VoxEU.org, 1 March.
Camatte, H, G Daudin, V Faubert, A Lalliard and C Rifflart (2021), “Estimating the elasticity of consumer prices to the exchange rate: an accounting approach”, ECB Working Paper No. 2610/ october.
Timmer, M, E Dietzenbacher, B Los, R Stehrer and GJ de Vries (2015), “An Illustrated User’s Guide to the Global Input-Output Database: The Case of Global Automotive Production”, Journal of international economics 23: 575–605.
Timmer, MP, B Los, R Stehrer and GJ de Vries (2016), “An Anatomy of the Global Trade Slowdown based on the WIOD 2016 Release”, Technical report.