Got Milk? The Effect of Export Price Shocks on Exchange Rates

I examine the effect of exogenous terms of trade shocks on an exchange rate by turning to New Zealand’s dairy auctions. Dairy is New Zealand’s largest export category, making up almost 20% of exports. Specifically, whole milk powder accounts for between 6 and 11% of total exports, and its price is determined in twice-monthly auctions. I use event studies to quantify the impact of surprise auction results on the New Zealand Dollar on a high-frequency basis. I find that a 1% increase in whole milk powder prices has a modest, but nevertheless significant, effect on the nominal exchange rate that does not seem to be explained by interest rate movements. Rather, the effect seems to be driven by a combination of two channels: a financial flows channel and an expenditure switching facilitation channel. I model this last channel by incorporating a non-traded sector into a small open-economy New Keynesian model, and I illustrate how nominal exchange rate changes can persist following a temporary export price shock, depending on the monetary policy rule. The methodology developed here can potentially be applied to other commodity exporters. ∗Email: hstein@g.harvard.edu. Website: https://scholar.harvard.edu/hillarystein. I am grateful to my advisers, Pol Antràs, Jeffry Frieden, Kenneth Rogoff, and Jeremy Stein, for their extensive support. I would also like to thank John Campbell, Gabriel Chodorow-Reich, Samuel Hanson, Matteo Maggiori, Adi Sunderam, Jesse Schreger, Ludwig Straub, and participants in the Harvard International, Finance, and Macroeconomics workshops, whose insightful comments have helped improve this paper. Finally, I would like to thank Susan Kilsby, Jared McConachie, and Nick Morris for their generosity with their time in discussions around the institutional details of the Global Dairy Trade auctions. I gratefully acknowledge receiving financial support from the Weatherhead Center for International Affairs and the Institute for Quantitative Social Science while working on this research.