Real export and import adjustments to account for exchange rate fluctuations

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This is an update of the December 2009 article Real Import and Export Adjustments to Account for Exchange Rate Fluctuations released in the Income and Expenditure Accounts Technical Series (13-604 no. 62).

Methodology change – first quarter of 2011

Background

As part of the process of calculating real gross domestic product (GDP) for a given period, nominal estimates of exports and imports are deflated to obtain the real value of international trade, absent of price or inflationary effects.

Statistics Canada produces monthly import and export merchandise trade price indexes which are used in this deflation. For the majority of these indexes, Statistics Canada uses a variety of proxy measures to derive these indexes in lieu of collecting observed import and export prices. These proxy measures include Canadian domestic prices from Statistics Canada's Industrial Product Price Index (IPPI) program, or U.S. domestic price indexes adjusted for variation in the Canada-U.S. exchange rate. In the case of the US proxies, 100% of the fluctuation in the exchange rate is applied to the U.S. domestic indexes to arrive at the Canadian import price variation.

These methodologies are based on assumptions about the similarities in price movements for domestic prices, international trade prices and world market prices, represented by U.S. price indexes, adjusted for exchange rate variations. Namely, that export and domestic prices behave in the same manner and that Canadian importers are subject to the same price changes as U.S. domestic purchasers, denominated in U.S. dollars. Although these relationships may hold during times of exchange rate stability, a review conducted in 2004 suggested that they did not hold when there were significant fluctuations in exchange rates. As a result, Statistics Canada has been adjusting the aggregate estimate of real exports and real imports to more accurately reflect the relationship between domestic prices, international trade prices and exchange rates. These adjustments serve to improve the overall estimate of real GDP.

Methodology change as of the first quarter 2008

In 2006, Statistics Canada initiated a program to increase the number of import and export prices it collects directly from Canadian importers and exporters. With the publication of first quarter GDP for 2011 and the revision to previously published data back to 2008, Statistics Canada will be utilizing these new prices in the deflation of international imports and exports. At this time, the prices cannot be incorporated at the commodity level, so the impact of these new prices will be incorporated in aggregate within the price of the import and export category 'other balance of payments adjustments'. In addition to the new prices, recent research on import data has suggested that the current assumption regarding the immediate impact of exchange rate movements on import prices should be lowered. The current methodology estimates that 96% of the change in the Canada-U.S. exchange rate is reflected in Canadian import prices. The revised methodology estimates that the immediate effect is 85% for the period 2008 to 2011.

The new data source and update to the exchange-rate methodology have been incorporated into the monthly and quarterly adjustments to the estimate of real imports and exports.  The adjustments are now as follows:

Adjustment to real exports

The adjustment to real exports is based on the analysis of three sets of information:

1. The first component of the adjustment to real exports is the impact of using new commodity prices from the Import Export Price Report (IEPR), applied at an aggregate level. To calculate this adjustment, survey prices are used to calculate IEPR-based constant dollar estimates on a by-commodity basis for exports covered by the new price survey; this estimate is compared to the constant dollar estimate calculated using the proxy indexes. The by-commodity differences between these estimates are aggregated to arrive at a total impact for exports.
2. The second component of the adjustment is a comparison between constant dollar exports and the quantity of units exported reported on customs documentation. The commodities selected for these comparisons are relatively homogeneous over time, consistently report quantity information, and are currently deflated using IPPI's. The movements in export quantities are compared with the movements in the constant dollar exports for the same commodities. The difference in growth rates between the quantity series and the constant dollar export series is used to derive the second component of the adjustment to real exports.
3. Finally, a set of economy-wide supply disposition models, as well as extensive coherence analysis between production and export estimates are used as an input into the adjustment to real exports.

Adjustment to real imports

The adjustment to real imports is based on the analysis of three sets of information:

1. The first component of the adjustment to real imports is similar to the IEPR adjustment on the export side. Surveyed prices are utilized to calculate IEPR-based constant dollar estimates on a by-commodity basis for imports covered by the survey; this estimate is compared to the constant dollar estimate calculated using the proxy indexes. The by-commodity differences between these estimates are aggregated to arrive at a total impact for imports.
2. The second adjustment lowers the immediate impact of exchange rate variations for those commodities where U.S. denominated prices, converted to Canadian dollars, are used as proxies to estimate import deflators. Recent research on detailed import data from the Canada Border Services Agency and the IEPR program has suggested that the current estimate of the immediate impact of the exchange rate on import prices should be lowered from 96% to 85%.
3. Finally, a set of economy wide supply disposition models, as well as extensive coherence analysis between supply and import estimates are used as an input into the adjustment to real imports.

Implementation

The components of each adjustment are aggregated with the other components of the respective adjustment to form a total real export adjustment and a total real import adjustment. These total adjustments are applied on a monthly basis to the price of the commodity 'other balance of payments adjustments'. These revisions will be incorporated on a monthly basis from January 2008 until the current period with the May 2011 release. The revised adjustment will be incorporated for a longer period of time with the historical revision of the Canadian System of National Accounts in June 2012.