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Over the last two years, the value of the dollar against the major currencies has dropped by more than 25 percent. With the dollar having depreciated so much, why haven't we seen a narrowing of the trade deficit, which in February (the latest month for which numbers are available) reached a new record of $61 billion? A dollar depreciation should bring about what economists call "expenditure switching:" As the cost of imports rises, Americans should start buying more goods made at home; in turn, our exports become less expensive for foreigners, which means foreign demand for our products should rise. This shift in exchange rates and prices should eventually correct the country's trade deficit.

But so far, Americans' appetite for imports has yet to slow. That's because, with the exception of oil, imports have not become that much more expensive. One reason is that about 30 percent of our imports come from countries whose currencies have either moved little (the Thai baht), stayed stable (the Chinese yuan), or fallen (the Mexican peso) against the dollar.

But another reason is the worldwide decline during the 1990s of what economists call "pass-through rates:" that is, the extent to which changes in the exchange rate induce changes in a country's import and export prices. A study by the economists Linda Goldberg and Jose Manuel Campa found that pass-through rates for the United States were significantly less than for other industrial countries. A 10 percent change in the dollar has generally yielded only a 2.5 percent change in American import prices within one quarter, and only a 4 percent price change after several quarters. Another study by the Federal Reserve found that pass-through was nearly zero. Indeed, in the case of the Japanese yen, even a 25 percent rise in the yen to dollar rate has generated little if any increase in the price we pay for Japanese goods.

Several factors help explain America's lower pass-through rate. Reduced inflation around the world has made prices less volatile, enabling exporters to ride out currency fluctuations without changing prices. As the United States imports more consumer goods (which have a lower pass-through rate compared with commodities), the overall pass-through rate for American imports has fallen. But perhaps most important, exporters don't want to risk losing market share in the large and competitive American market-even if that means decreasing their own profit margins to keep prices stable in the United States.

Low pass-through means that Americans have not yet lost their purchasing power abroad despite the dollar depreciation, and therefore we can continue to enjoy living beyond our means. Over the long run, though, the enormous trade imbalance is not sustainable. Low pass-through means that it will take a much bigger drop in the dollar to change prices enough to induce switching and correct the trade deficit. In fact, our colleague Ted Truman calculates that between the depreciation of the dollar and the loss in spending power, this adjustment could end up costing every American $2,350. The larger the eventual depreciation, and the longer we wait, the greater our postponed pain promises to be.