A Structural Approach to Explaining Incomplete Exchange-Rate Pass-Through and Pricing-to-Market

Abstract

The continuing depreciation of the dollar against other major currencies, coupled with concerns about the impact of China’s exchangerate policy on domestic prices, has spurred new interest in the exchange-rate pass-through literature. A recent study by economists at the Federal Reserve Board of Governors (see Mario Marazzi et al. 2005) attracted wide attention by documenting a steady decline over the past decade in the pass-through of exchange rates into US import prices. This finding was later challenged by a study published by the Federal Reserve Bank of New York (Hellerstein, Deirdre Daly, and Christina Marsh 2006), which demonstrated that the finding of such a decline depends crucially on the specification of the pass-through regression, and in particular the inclusion of commodity prices. This exchange highlights the need to understand the structural determinants of exchange-rate pass-through, not only because such understanding is important when trying to forecast future pass-through patterns, but also because it provides guidance regarding the specification of the appropriate reduced-form regression and, more generally, measurement of pass-through. The increased availability of micro data on prices and quantities means that research uncovering these determinants is more promising than SourceS of InternatIonal PrIce StIckIneSS †