Low Exchange Rate Pass-through Research Articles

Dollar invoicing, global value chains, and the business cycle dynamics of international trade

This paper reexamines the relationship between monetary policy, exchange rates and international trade in a world characterized by the dominant currency paradigm and global value chains. Using a three-country dynamic stochastic general equilibrium (DSGE) model, it documents key differences between the response of gross and value added trade flows to interest rate shocks, and offers a framework to test them in the data. The exercise uncovers a new margin of adjustment where value added trade flows react significantly to shocks, even as gross trade flows that are typically measured in the data remain relatively flat. This provides a reconciliation between the output effects of textbook models that assume producer currency pricing and no value chains, and the low aggregate exchange rate passthrough and muted adjustment of gross trade flows that has been documented in the data.

Automobile exports: Exchange rate, export price and retail price

AbstractBy using information on the geographical locations of exporting firms, we transform a national‐level dataset into a quasi‐firm‐product‐level dataset. First, by restricting the dataset to the two exporting ports out of over 100 ports, consistent with the multiproduct exporter model, we find heterogeneity in the exchange rate pass‐through (ERPT) among the auto models of a single automaker. We find weak evidence that the core product has a lower ERPT. Second, coupled with the manufacturer's suggested retail price in the US market, we find that the sales margins of US distributors have shrunk substantially, particularly when the US dollar depreciated after the global financial crisis. We find supporting evidence that a higher‐quality product has a lower ERPT.

Exchange Rate Passthrough to Sectoral Prices: Evidence from Zambia

The objective of the study was to examine the exchange rate pass through (ERPT) to sectoral prices in Zambia. We look at the agriculture, manufacturing and services sectors. For analysis, we use the SVAR model with annual data from 1983 to 2017. The results from the study showed that the ERPT is less than complete in the three sectors but highest in the services sector followed by manufacturing and agriculture sectors respectively. High ERPT in the services sector might be because the services sector is dominated by final consumer services such as wholesale and retail trade, transportation and tourism industry which might be sensitive to exchange rate movements. High ERPT in the manufacturing sector could be because most of the raw materials that are used in the manufacturing sector are imported. Lower ERPT in the agriculture sector might suggest that items in this sector are less sensitive to exchange rate movements. Keywords: ERPT, sectoral price inflation, Forecast error variance decomposition DOI: 10.7176/JESD/13-22-07 Publication date: November 30 th 2022

Exchange Rate Passthrough to Sectoral Prices: Evidence from Zambia

The objective of the study was to examine the exchange rate pass through (ERPT) to sectoral prices in Zambia. We look at the agriculture, manufacturing and services sectors. For analysis, we use the SVAR model with annual data from 1983 to 2017. The results from the study showed that the ERPT is less than complete in the three sectors but highest in the services sector followed by manufacturing and agriculture sectors respectively. High ERPT in the services sector might be because the services sector is dominated by final consumer services such as wholesale and retail trade, transportation and tourism industry which might be sensitive to exchange rate movements. High ERPT in the manufacturing sector could be because most of the raw materials that are used in the manufacturing sector are imported. Lower ERPT in the agriculture sector might suggest that items in this sector are less sensitive to exchange rate movements. Keywords: ERPT, sectoral price inflation, Forecast error variance decomposition DOI: 10.7176/JRDM/88-04 Publication date: October 31 st 2022

Exchange rate pass-through to domestic inflation in a pricing model incorporating distribution chain structure

ABSTRACT This study investigates the pass-through of exchange rate shocks to different aggregate prices in China. The baseline analysis is carried out with vector autoregressive models incorporating a distribution chain of pricing, and various modifications are examined for robustness. The central results show an appreciation of the local currency tends to suppress domestic inflation at the early production stages, although the pass-through effect only amounts to a moderate degree for consumer prices. As the contribution of external factors to the persistently low inflation environment mostly has been modest, the paper suggests that the monetary authority can contribute to the permanent component of low exchange rate pass-through to domestic inflation, by continually conducting a credible and efficient stable-inflation policy.

Comfort in Floating

Chile offers an example of a country that has overcome the fear of floating by reducing balance sheet mismatches, enhancing financial market development, as well as improving monetary, fiscal, and political institutions, and strengthening policy credibility. Under the floating regime, Chile’s economic adjustment to external shocks appears significantly improved, and its exchange rate pass-through has substantially declined. Our results reinforce the case that moving to a clear and credible floating regime can be associated with a reduction in the fear of floating via economic transformation (like smaller balance sheet mismatches, a larger hedging market, and a lower exchange rate pass-through).

Comfort in Floating: Taking Stock of Twenty Years of Freely-Floating Exchange Rate in Chile

Chile offers an example of a country that has overcome the fear of floating by reducing balance sheet mismatches, enhancing financial market development, as well as improving monetary, fiscal, and political institutions, and strengthening policy credibility. Under the floating regime, Chile's economic adjustment to external shocks appears significantly improved, and its exchange rate pass-through has substantially declined. Our results reinforce the case that moving to a clear and credible floating regime can be associated with a reduction in the fear of floating via economic transformation (like smaller balance sheet mismatches, a larger hedging market, and a lower exchange rate pass-through).

Deep habits and exchange rate pass-through

Habit persistence at the level of individual goods varieties can explain incomplete exchange rate pass-through to international prices. Deep habits give rise to a dynamic import demand function that leads to import price markup adjustments, independently of nominal pricing frictions. Augmenting a two-country DSGE model with deep habits, we obtain low exchange rate pass-through to import prices even when nominal local currency price rigidities are negligibly low. As nominal pricing frictions become more important, the presence of deep habits further impedes the pass-through of exchange rate fluctuations. Estimating model variants with limited information as well as full information methods, we find that the deep habits model requires much lower degrees of nominal price rigidities to match empirical measures of the pass-through of exchange rate fluctuations to US import prices.

Exchange rate pass-through and product heterogeneity: Does quality matter on the import side?

This paper investigates theoretically and empirically the heterogeneous response of exporters to real exchange rate fluctuations due to the quality of imported inputs and exported output. We develop a model where the production of high-quality products requires high-quality inputs sold in monopolistically competitive foreign markets. The model predicts that exporters using imported inputs have low exchange rate pass-through, but this effect is weaker for firms shipping high-quality goods. This is due to the heterogeneous price adjustments of foreign suppliers selling inputs of different quality. We test the predictions of the model using Italian firm-level trade data for the period 2000–2006. The empirical analysis shows that the imports of intermediates have a significantly weaker effect in reducing the exchange rate pass-through into the export price of high-quality varieties. By showing that the import price of high-quality inputs is less sensitive to exchange rate variations, we provide evidence supporting the theoretical hypothesis that the pricing power of input suppliers weakens the import channel.

Monetary policy credibility and exchange rate pass-through: Some evidence from emerging countries

Considering external constraints on monetary policy in emerging countries, we propose a semi-structural vector autoregressive model with exogenous variables (VARX) to examine the exchange rate pass-through to domestic prices. We demonstrate that a lower exchange rate pass-through is associated with a credible monetary policy aiming at controlling inflation. The empirical results suggest that the exchange rate pass-through is higher in Latin American countries than in East Asian countries. The exchange rate pass-through has declined after the adoption of an inflation targeting monetary policy.

Exchange Rate Pass-through, Unemployment and Optimal Implementable Monetary Policy Rule for Emerging Economies

This paper develops a small open economy model with nominal rigidities and search-matching frictions to study the implications of exchange rate pass-through for monetary policy in emerging countries. I find that, with complete exchange rate pass-through, the optimal policy rule features unemployment targeting as well as inflation targeting. However, the welfare gain from responding to unemployment fluctuations diminishes as the rate of exchange rate pass-through to import prices decreases. With low exchange rate pass-through, the optimal monetary policy is strict inflation targeting.

Missing Import Price Changes and Low Exchange Rate Pass-Through

A large body of empirical work has found that exchange rate movements have only modest effects on US inflation. However, exchange rate pass-through may be underestimated because some price changes are missed when constructing price indexes. We investigate downward biases that arise when items exit or enter the US import price index. Using Bureau of Labor Statistics microdata, we find that, although potentially large in theory, the empirical biases are modest over typical forecast horizons. As such, the empirical evidence continues to support the conclusion that pass-through to US import prices is low. (JEL C43, E31, E52, F31)

Exchange Rate Pass-Through in the Global Economy: The Role of Emerging Market Economies

This paper estimates export and import price equations for 40 countries—including 22 emerging market economies (EMEs)—and aims to understand heterogeneity across countries in the degree of exchange rate pass-through to import and to export prices. The results indicate that (i) export price elasticities are higher in EMEs than in advanced economies; (ii) trade elasticities are primarily influenced by macroeconomic factors; (iii) export and import price elasticities tend to be correlated across countries; (iv) lower exchange rate pass-through in the United States, compared with other advanced economies, can be related to the geographical distribution of U.S. imports, more heavily concentrated in countries with high elasticity of export prices. Overall, these results yield an enhanced understanding of exchange rate pass-through, emphasizing the role of external factors.

Importers, Exporters, and Exchange Rate Disconnect

Large exporters are simultaneously large importers. We show that this pattern is key to understanding low aggregate exchange rate pass-through as well as the variation in pass-through across exporters. We develop a theoretical framework with variable markups and imported inputs, which predicts that firms with high import shares and high market shares have low exchange rate pass-through. We test and quantify the theoretical mechanism using Belgian firm-product-level data on imports and exports. Small nonimporting firms have nearly complete pass-through, while large import-intensive exporters have pass-through around 50 percent, with the marginal cost and markup channels contributing roughly equally. (JEL D24, F14, F31, L60)

Missing Import Price Changes and Low Exchange Rate Pass-through

A large body of empirical work has found that exchange rate movements have only modest effects on inflation. However, the response of an import price index to exchange rate movements may be underestimated because some import price changes are missed when constructing the index. We investigate downward biases that arise when items experiencing a price change are especially likely to exit or to enter the index. We show that, in theoretical pricing models, entry and exit have different implications for the timing and size of these biases. Using Bureau of Labor Statistics (BLS) microdata, we derive empirical bounds on the magnitude of these biases and construct alternative price indexes that are less subject to selection effects. Our analysis suggests that the biases induced by selective exits and entries are modest over typical forecast horizons. As such, the empirical evidence continues to support the conclusion that exchange rate pass-through to U.S. import prices is low.

Limits of floating exchange rates: The role of foreign currency debt and import structure

A traditional argument in favor of flexible exchange rates is that they insulate output better from real shocks, because the exchange rate can adjust and stabilize demand for domestic goods through expenditure switching. This argument is weakened in models with high foreign currency debt and low exchange rate pass-through to import prices. The present study evaluates the empirical relevance of these two factors. We analyze the transmission of real external shocks to the domestic economy under fixed and flexible exchange rate regimes for a broad sample of countries in a Panel VAR and let the responses vary with foreign currency debt and import structure. We find that flexible exchange rates do not insulate output better from external shocks if the country imports mainly low pass-through goods and foreign indebtedness is high.

A regime-switching analysis of pass-through

We empirically investigate how various economic factors affect the changes in the pricing policies of exporters, in particular changes in the exchange rate pass-through. Assuming exporters set prices following either a high or a low pass-through pricing policy, and assuming that the transition probabilities between these pricing policies depend on market concentration, exporting country’s market share and monetary stability, we estimate a Markov regime-switching model, using data we have collected on imported cars to the United States. Our findings show that the “low pass-through” regime is characterized by: lower exchange rate pass-through, low response to misalignments in the firm’s relative price, low volatility of exogenous shocks, and higher duration. When we decompose the changes in the pass-through in our sample, we find that monetary stability has been the most important factor behind the decline in the pass-through. Monetary stability explains more than 50% of the decline in the exchange rate pass-through, while country market share and market concentration explain about 25 and 10%, respectively.

Importers, Exporters, and Exchange Rate Disconnect

Large exporters are simultaneously large importers. In this paper, we show that this pattern is key to understanding low aggregate exchange rate pass-through as well as the variation in pass-through across exporters. First, we develop a theoretical framework that combines variable markups due to strategic complementarities and endogenous choice to import intermediate inputs. The model predicts that firms with high import shares and high market shares have low exchange rate pass-through. Second, we test and quantify the theoretical mechanisms using Belgian firm-product-level data with information on exports by destination and imports by source country. We confirm that import intensity and market share are the prime determinants of pass-through in the cross-section of firms. A small exporter with no imported inputs has a nearly complete pass-through, while a firm at the 95th percentile of both import intensity and market share distributions has a pass-through of just above 50%, with the marginal cost and markup channels playing roughly equal roles. The largest exporters are simultaneously high-market-share and high-import-intensity firms, which helps explain the low aggregate pass-through and exchange rate disconnect observed in the data.

An empirical study of exchange rate pass-through in China

This paper seeks to estimate exchange rate pass-through in China and investigate its relationship with monetary policy. Linear and VAR models are applied to analyze robustness. The linear model shows that, over the long run, a 1% appreciation of NEER causes a decline in the CPI inflation rate of 0.132% and PPI inflation rate of 0.495%. The VAR model supports the results of the linear model, suggesting a fairly low CPI pass-through and relatively higher PPI pass-through. Furthermore, this paper finds that, with the fixed exchange rate regime, CPI pass-through remains higher. The exchange rate regimes influence on CPI pass through, combined with the fact that appreciation diminishes inflation, suggests that the Chinese government could pursue a more flexible exchange rate policy. In addition, reasons for low exchange rate pass-through for CPI are analyzed. The analysis considers price control, basket and weight of Chinese price indices, distribution cost, and imported and non-tradable share of inputs.

Limits of Floating Exchange Rates: The Role of Foreign Currency Debt and Import Structure

A traditional argument in favor of flexible exchange rates is that they insulate output better from real shocks, because the exchange rate can adjust and stabilize demand for domestic goods through expenditure switching. This argument is weakened in models with high foreign currency debt and low exchange rate pass-through to import prices. The present study evaluates the empirical relevance of these two factors. We analyze the transmission of real external shocks to the domestic economy under fixed and flexible exchange rate regimes for a broad sample of countries in a Panel VAR and let the responses vary with foreign currency indebtedness and import structure. We find that flexible exchange rates do not insulate output better from external shocks if the country imports mainly low pass-through goods and can even amplify the output response if foreign indebtedness is high.