Import Response to Exchange Rate Fluctuations: A Micro-Level Investigation

Abstract

This paper presents theory and evidence on firms' import responses to exchange rate fluctuations using highly disaggregated data of Chinese imports from OECD countries. The paper first develops a heterogeneous-firm trade model and predicts firms' import responses at both the extensive and intensive margins: when domestic currency appreciates, more firms start importing and more products are added into the imported inputs bundle (extensive margin effect), and the import value by each firm also increases (intensive margin effect). The model also predicts that those import responses are more profound for firms in ordinary trade than for those in processing trade. Next, the paper empirically investigates firms' import responses to exchange rate fluctuations at extensive and intensive margins in both the short run and the long run, and all the model predictions are confirmed. The predicted pattern is more robust in the long run than in the short run. We also find variations among import responses under different exchange rate regimes (including a fixed exchange rate regime, an expected appreciation regime, and a confirmed appreciation regime). Finally, we investigate the exchange rate pass-through to import prices and find that incomplete pass-through has declined.