Exchange rate uncertainty and import prices in the euro area

Boris Blagov

doi:10.1111/roie.12434

Abstract

AbstractThis paper analyzes the effects of exchange rate uncertainty on the pricing behavior of import firms in the euro area. Uncertainty is measured via the volatility of the structural shocks to the exchange rate in a nonlinear vector‐autoregressive model framework and is an important determinant of import prices. An increase in exchange rate uncertainty is associated with a fall in prices on average, which suggests that the exchange rate risk is borne by the importers. Controlling for the origin of imports (within or outside the euro area) is important for assessing the impact of exchange rate movements on prices.

Highlights

Does an increase in exchange rate uncertainty influence import prices? How do export and import firms react when faced with elevated levels of exchange rate fluctuations? Since abandoning the gold standard, exchange rates have exhibited high volatility while most macroeconomic aggregates have remained stable (Baxter & Stockman, 1989; Corsetti, Dedola, & Leduc, 2008; Obstfeld & Rogoff, 2000)
Intra‐euro area trade accounts for about two‐thirds of the trade volume within the European union (EU28). This could result in a bias arising in exchange rate to import prices (ERPT) estimates, since a large share of the dynamics of the import prices might not be explainable through changes in the exchange rate
Regarding the ordering we put the import prices below the exchange rate, as is custom in the studies on ERPT, which is consistent with Equation 4, our results prove robust to the permutation of those variables

Summary

Introduction

Does an increase in exchange rate uncertainty influence import prices? How do export and import firms react when faced with elevated levels of exchange rate fluctuations? Since abandoning the gold standard, exchange rates have exhibited high volatility while most macroeconomic aggregates have remained stable (Baxter & Stockman, 1989; Corsetti, Dedola, & Leduc, 2008; Obstfeld & Rogoff, 2000). This allows us to estimate how import prices react following an increase in the exchange rate uncertainty.3

Objectives

Results

Conclusion