The trade imbalance between Taiwan and the United States remains at a high level despite the sharp depreciation of the U.S. dollar since 1986. To explain the phenomenon, this study develops an econometric examination of the direct pass-through behavior and the indirect cost reduction effect of the exchange rate changes on Taiwan's export prices as well as on its exports to and imports from the U.S. The results show that the major improvement is from Taiwan's import side. On Taiwan's export side, exchange rate changes lead to a decrease of Taiwan's exports to the U.S., but these effects would be offset by a lower export price due to the incomplete pass-through. In addition to the aggregate level, I also examine the effects of exchange rate changes in six commodity groups for both imports and exports because the demand and competition conditions may differ between industries. Evidence supports the viewpoint that Taiwan's exporters do not completely pass-through currency appreciation to export prices in both aggregate and industry levels.; Since Taiwan has an export-oriented economy and almost 95 percent of its imports are capital goods and raw materials, the channels of incomplete pass-through are profit-squeezing and cost-reduction. Also, I investgate the impact of exchange rate changes on the geographical diversification of Taiwan's external trade. After examining the U.S. share in Taiwan's imports, I show that the U.S. has little gain in Taiwan's import market. Even though U.S. exports to Taiwan have increased, its share in Taiwan's import market did not increase. Taiwan has also expanded its exports to other countries, especially Hong Kong; and the trade structure would gradually adjust to the new international circumstance.
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